I’m so excited to be reading this book. I just purchased it last night and took a quick look through the table of contents. I’ve long been interested in the world of gold and silver and will be writing about everything I learn here in this blog. There’s actually quite a bit of history when it comes to investing in gold. What I’m most attracted to is the fact that these two precious metals are recognized all over the world. It’s not like you can only deal with it here in America.
It’s a great time to learn about why gold is important in the world of high finance. With COVID 19 still very active and business destruction all over the place, our United States government is printing money like crazy. And now with the Biden administration taking charge in just a few days and with Joe’s plan for a 1.9 trillion dollar stimulus on the heels of a previous giant stimulus, I’m beginning to hear whispers of inflation sure to peek around the corner. True, any substantive inflation has eluded us for the past decade, but I have to wonder if these latest actions will finally introduce it to the realm of possibilities. It seems that so many of those who predicted that the money printing of the past would spell our ultimate doom were wrong, but my question is, will they finally have their day? Since 2008, I’ve been reading and hearing about $5,000 gold per ounce. Has that happened? Far from it. I’ve heard about “breakouts” and about how “gold is going to shoot through the ceiling.” Has either of those things happened? No, they haven’t. But that doesn’t mean that they won’t some time in the future.
From what I’ve learned, there’s a certain type of person who invests in gold. These people aren’t trying to make money from their investment. They’re not business people. They’re not speculators in the traditional sense. Many of them aren’t even investors. Do you want to know who they are? They’re security freaks. They’re the kind of people who think the entire thing is going to go to hell in a hand basket one day and when it does, they’ll be sitting back with a beer watching it all unfold. And they’ll be saying, “I told you so. You should have listened.”
I’ve invested in gold. I bought heavily back in 2008-2010 and for most of the years since, I’ve forgotten all about it. I’m happy to report that my investment has doubled during that time, but the price per ounce hasn’t risen nearly as I had expected. Owning precious metals gives me a good feeling though. It’s like having an insurance policy that gets more and more valuable as the years go on.
As I said, I’m eager to learn about what Mike has to say. I’ve been watching him on YouTube for years and years, but what I’ve seen has come to me in bits and pieces. I’d like to finally read the story in its entirety. What’s the best part? Well, I’ll be writing independent posts here on this blog that summarize what I’ve learned from each chapter. My hope is that these posts will inspire discussion and conversation about this captivating topic. You can reply to my posts and initiate a conversation down below.
Michael Maloney’s Gold & Silver Preface
I can already tell that I’m going to love this book. I’ve been thinking about how best to go about writing about it and I’ve decided to cover it with a skeptical eye. I’d be foolish to take any investment advice for face value, especially in the realm of precious metals. Lots has changed over the past thousands of years and to compare historical gold investing with investing of today, or, how to say this more clearly, to act as if the investing of precious metals in 1900 is closely aligned with that of today would be akin to burying my head in the sand. You’ll see what I’m referring to below.
I do want to tell you before I begin, though, that I love gold and silver. I truly believe that no matter if you’ve ever seen either of these things before in your lifetime, you would hold them tightly and cherish them if they were given to you. There’s something innate in the human spirit that finds these metals precious. No one needs to tell you this. If you were a native who’s people were locked in the forests of South America for the past thousand years and someone handed you a piece of gold, you’d treasure it as if you knew its value in the outside world. There’s something magical about gold. I’m not sure anyone has ever discovered what that is, but it’s certainly there.
Michael Maloney’s preface is only a few paragraphs long. I’d like to pick it apart and discuss each of its ideas. There are a few general assumptions that I’d like to counter. Or talk about.
The first few paragraphs of Mike’s preface discuss how fiat currencies have always been debased by governments globally. Essentially, because of borrowing and the expansion of a currency in a set market (my words), that currency eventually loses the value it once had, driving up prices. Or, to put it more simply, you’ll need more pieces of paper to buy the same thing. Because wages rarely rise with costs, the average person generally feels the pinch. Mike says that once the debasement of a currency reaches a certain point, the citizens of a society realize that it’s no good anymore and they turn to gold and silver. Two metals that seem to hold their value steadily. This rush to precious metals will cause a realignment of its value in comparison to their debasing currency. I assume this is why we see gold valued at $300 per ounce one year and then $1,800 per ounce a few years later.
At first glance, this all seems to make sense. I would, however, like to discuss how today’s world differs from yesterday’s or even how the currency of a first world nation differs from that of a third world. To begin, Let’s talk about the world of the past. A hundred years ago, there was no such thing as a computer. Financiers on Wall Street and across Europe relied on letters and telegraphs for communication. If a market in any particular area was crashing, the response was slow. For a central bank to intervene, it took ages and that intervention was oftentimes too late. And because much of the world’s currency was tied to the value of gold, bankers had to locate and secure their wealth before injecting it into the market as a correction. As you can imagine, this took time and sometimes it didn’t happen at all. It’s my guess that, aside from the inherent corruption of the financial markets and some bankers themselves, there wasn’t a lot a financial organization or government could do if something fishy was going on in the markets. To put it bluntly, to talk about today’s currency market compared to markets of one hundred, two hundred, a thousand years ago is pretty much useless. In today’s world, and we’ve seen this time and time again, if there’s a blip in the market, a computer can simply make a buy large enough to calm the blip. No one even needs to be at the computer operating it. Triggers can be coded into the Fed’s software that simply makes purchases when needed and sales when needed. We’ve seen this type of thing occur wildly across the past decade and especially in 2019 and 2020. So all those written letters and telegrams of old don’t need to be discussed any longer. Things aren’t the same. Let’s not compare apples and oranges.
Next, I’ll discuss banking systems of developed countries versus those of under developed countries. Okay, let’s just get this out there right now – banking systems are oftentimes used to manipulate the actions and political values of a nation. If you aren’t sure what I’m referring to, read up on Andrew Jackson. The book The Age of Jackson by Arthur M. Schlesinger Jr. is a good one. You can also read Confessions of an Economic Hit Man by John Perkins. And let’s not forget the most important book of all, The Creature from Jekyll Island by G. Edward Griffin. These three books should enlighten you to the shady activities that go on around the world every day. So when someone talks about how a currency is inflating into oblivion, don’t for a second think that it’s due to some force of nature that’s out of our control. Banks inflate currencies to ruin them, put pressure on governments, consolidate currencies, and establish central banks and other banking structures. This happens much more frequently in under developed countries than developed ones because there simply isn’t the wherewithal, education, experience, or framework in under developed countries to counter the effort by the banks. The savvy isn’t there and oftentimes the political structure is corrupt to its core. Eventually, all nations and currencies will fall to the bankers, but again, don’t be fooled into thinking that it isn’t their fault. It is and it’s completely planned and on purpose. But just because this is the case, it doesn’t mean that you shouldn’t protect yourself by buying and storing gold and silver. Now that you’re slightly more educated about the process, you should actually have more reason to do so. So basically, I think what Mike Maloney says is true, it’s just that his reasoning and rationale need to be fleshed out more extensively. Perhaps it is, as I haven’t even begun to read his book yet.
In the second half of Mike’s preface, he talks about transfers of wealth. I agree with him wholeheartedly on this one. Since I’ve begun entertaining myself with global finance and learning about the many stock markets around the world, I’ve seen this phenomenon occur time and time again. Markets rise and fall and as they do, I watch who buys and sells. More often that not, the little guy sells when markets are at their bottoms and big guys buy. When markets are at their tops, little guys buy and big guys sell. A few years ago, I decided to do my buying and selling when I thought the wealthy do their buying and selling. It’s worked out marvelously. I will tell you though, it’s gut wrenching to go against my instincts. But it’s worked out so well. Of course, market fluctuations don’t have much to do with gold related transfers of wealth. Bigger things do. Currency collapses. Runaway inflation. These things can make millionaires out of thousandaires. Owning a few hundred ounces of gold under the right conditions can set a man up for life. Now there’s a transfer of wealth worth learning about.
Finally, I will note that I’ve yet to see the price of gold increase or decrease based on any sort of actual currency valuation. The gold bugs like to talk about the coming collapse of the dollar and the “big one” that’s going to carry the price of gold to $8,000 an ounce. I honestly don’t think any of these types of things are going to happen. The only factors I’ve seen influence the price of precious metals have revolved around uncertainty. Sure, slow rises in prices can be attributed to massive government and central bank stimulation, such as we’re seeing now under the guise of COVID 19, but by and large, the huge jumps in the prices of gold we’ve witnessed over the past two decades have had more to do with the housing and mortgage market crash and the global pandemic. Neither of which had anything to do with inflation. Of course, that’s not to say that both of these things haven’t and won’t cause inflation, but I’ve yet to see any evidence that they have. And this goes back to how keenly and quickly central banks can inject and remove liquidity into the financial markets. Unlike days of old.
Is the U.S. Dollar Crashing?
There’s a claim made in the introduction of Michael Maloney’s book called Guide to Investing in Gold & Silver. It’s a claim that I’ve been hearing since I was born. Every year, more and more individuals add their voice to the chorus of folks who say the U.S. dollar is crashing. “It’s right around the corner!” “We’re all doomed!” It’s not a difficult claim to make. All it takes is a cursory look at the national debt and current interest rates. Rates are at historic lows, debt is at historic highs, if inflation rises, which prompts a rise in interest rates, the United States government would default on their debt. For most years since 1978 (with a short break during the Clinton/Bush era), the debt to GDP ratio has been getting worse. The CBO says that if the current trajectory remains, by the year 2049, the percentage of debt to GDP will be just short of 160%. That’s not good, but really, that’s not the only metric we should be looking at. What’s more troubling is how much money this nation is currently giving away to banks and investors as interest every year. I don’t care how much debt is being held. What I care about is money that could be spend better elsewhere. Don’t you find it strange how many people and politicians in this country argue about things they would like to see funded, but rarely mention the very thing that could supply them with the funds they crave? Look at the national debt interest folks. That should be the first place you look. You could have universal health care until the cows come home if you weren’t giving away all of our money. But I digress.
I would like to introduce a hypothetical to this post. I’ll get to that in a moment. First, in Mike’s introduction, he jumps to a few conclusions that I’d like to address. He says that the dollar is on its way to crashing. He says that our national spending is unsustainable. He says that the price of gold and silver will skyrocket the moment the dollar sees trouble. He says that the relationship between equities and commodities is cyclical. He says that there’s also a cyclical nature to fiat currency as it relates to hard currency, such as the U.S. dollar to gold and silver. Here’s my question: what if Mike is wrong?
I’ll admit that there is a cyclical nature to investing. I’ll also admit that the price of gold has seen its ups and downs throughout history. The problem with Mike’s claims is that some of them are targeting the U.S. dollar as if it’s the same thing as a Zimbabwe banknote or the Venezuelan bolívar. It’s not. the U.S. dollar is a reserve currency. While most people like to say it’s not backed by anything, I beg to differ. In truth, we don’t know if it’s backed by anything. We’re not bankers. We don’t work for the Federal Reserve or the Bank of International Settlements. Maybe it is backed by gold. Or oil. Or the moon. Or real estate. Or real estate on the moon. Or patents. Or the productivity of the American worker. Or the potential earnings through the income tax system. Who knows? We certainly don’t. To jump to a conclusion about something which we know nothing of is plain silly. People like to beat up on the dollar, but I must say, it’s very resilient. Yes, I’m confident that it’ll be replaced by something sooner rather than later, but it’s impossible to know who’ll benefit from that replacement. Will that new currency be stronger than gold? If so, the price of gold will go down. Who says that any replacement currency need be weaker than gold? What if the replacement is backed by the potential productivity of workers across the entire globe? What of gold then? The problem is, we simply don’t know. I suppose that’s the benefit of owning gold though – many view it as insurance against a weakening dollar, as I alluded to in my previous post. If you own some, you won’t need to worry as much as those who own none. It’s a small price to pay for that kind of security. And again, I want to remind you that I love gold and silver. I’m an ardent collector. No one could ever talk me out of my passion for owning gold, not even Warren Buffett.
If you accept my prediction that the U.S. dollar will be replaced, ask yourself what might instigate that replacement. Will it be inflation spiraling out of control? That seems to be the consensus. Although, I feel compelled to remind you that inflation has been flaccid for over a decade in spite of multiple injections of enormous amounts of liquidity into the economy on multiple occasions. Perhaps this latest COVID round will get that off the ground. These are some big injections. Will the replacement stem from a default on paying the national debt of the United States? Will other nations lose confidence in the dollar if its credit rating drops? I suppose that loss of confidence will cause a lack of value, which is certainly akin to inflation. Perhaps Mike is correct. Maybe there is more than one route to a devaluation of currency, no matter if it is a reserve or not.
Here are the hypotheticals I’d like to introduce that if accepted, may explain some of the erratic behavior we see coming from the federal government and the Federal Reserve. What if these skyrocketing inflationary periods only apply to smaller, more national currencies? Currencies that belong to Argentina, Zimbabwe, and Hungry? What if larger currencies are much more resistant to those increases? What if computers and algorithms are playing a much greater part in today’s monetary policy than we’re aware of? What if central banks around the world are able to react much more quickly to blips and crashes in the market? What if these same algorithms are able to predict what might happen and then compensate for those instances? Is this why the dollar has been so stable over the past 10 years with very little inflation? Are we seeing the success of Modern Monetary Theory? What if our nationalistic view of “national” debt is all wrong? We see things like foreign aid and loans to allies. Bail outs to global corporations and the like. What if the money foreign investors and central banks loan to the United States doesn’t only go to funding the United States? What if the United States is sort of like a bank in and of itself, which loans American dollars around the world. Would the national debt seem so large to us if this were the case? Do we know the internal workings of the Treasury and the Fed? I think not.
I don’t like working off faulty premises, or at least premises that we’re not sure about. I don’t like reading things like, “the dollar will collapse because our spending is unsustainable.” Who says it’s unsustainable? Who says that an entirely new economy isn’t being born as I write this? What if space travel is right around the corner? Artificial intelligence? What if all nations on earth began digging caverns in mountains so we can all live underground? If any of these things were the case, the current amount of currency in the economy would be a drop in the bucket compared to what would be necessary. Can you imagine if there was no such thing as debt and banking? We’d all be living in mud huts if that were the case. There would be no internet. Can you imagine if currencies around the world were still backed by gold? There would hardly be any currency at all. There would be no capital, no expansion, no nothing. We’d be locked in the 1800s.
Look, I have no idea if I’m wrong or right here. I will tell you this though – before I jump to conclusions, I need more information. I need facts and very persuasive evidence that would lead me towards a rational conclusion. I’ve been listening to gold bugs for two decades tell me that the big one is right around the corner. I’ll still waiting. So until I see that happen, I’ll remain skeptical.
What’s the Difference Between Currency & Money?
This is going to be a great post for those who are new to all this. I can remember back a decade or so when I first became interested in gold. I learned all there was to learn about how currencies rise and fall. And why. The real reasons why, not the fabricated reasons that revolve around this crisis or that. It’s wildly interesting and if you’d care to learn more, I highly recommend reading The Creature from Jekyll Island by G. Edward Griffin. It’s a thick book, but nothing you can’t conquer.
Currency vs. Money
Let me ask you something. One thousand years ago, do you think the United States Federal Reserve note that says $100 (a $100 bill) on it was worth anything? I hope you answered in the negative. Alas, the United States of America hadn’t even been born yet. Here’s another question for you. One thousand years ago, do you think one ounce of gold was worth anything? I hope you answered in the affirmative because gold has held value pretty much as long as anyone knows. Do you think a $100 bill from one hundred years ago was worth the same thing as $100 today? The answer is no. The $100 from one hundred years ago bought a heck of a lot more than $100 does today. I remember walking down to the corner store when I was a kid and buying a pack of gum for twenty five cents. That same pack is at least a dollar now. I remember when a gallon of milk cost $1.14. When a postage stamp cost fifteen cents. When a new car cost $7,000. When a dozen eggs cost fifty cents. What happened between the times when all of these things cost much less than they do now and today? Well, the U.S. dollar has devalued, for one. If you aren’t familiar with the term in regards to currency, devalue means to lose value. To be eaten away. To not be worth what it used to be worth.
Did you notice how I used the term currency in the previous paragraph? What is currency, anyway? And how does currency differ from money? I’ll keep things simple and explain the concept like this: currency holds no intrinsic value. Paper money around the world is considered currency. The number you see in your bank account is comprised of currency. If the government that issued a certain currency happened to fail, there’s a good chance a whole bunch of people would be sitting there with valueless paper in their grips. It’s happened before. Don’t doubt that it won’t happen again. Ask yourself this question when trying to determine whether what you have in your hand is currency or money. If you were to dip your paper in bleach and have all design disappear, would that paper by worth anything? If the answer is no, the you’ve got currency. Conversely, if you were to deface a piece of gold so you couldn’t tell from which nation it was minted, would that gold be worth anything? If the answer is yes (which it is), then you’ve got money.
Currency, by definition, is a medium of exchange. It doesn’t do well when it sits still. It’s an agreed upon vehicle for purchasing assets of value as well as a variety of other things. You can ask for a currency when selling something and offer currency when buying something. There’s nothing inherently wrong with currency and I’m sure the world would be quite an awful place to live if there was no such thing. The fact remains though, currency in and of itself is valueless.
Money, by definition, holds a value unto itself. Yes, it’s an agreed upon medium of exchange as well, but it’s also worth something. I suppose you can make a pillow case out of dollar bills and that pillow case might hold some value, even if the currency didn’t, but that’s about it. Gold and silver are valuable elements. So are other precious metals. I’ll admit that most of their value is derived from human nature. We as humans covet gold and yearn to acquire and hold it, but it’s also used in industry and exchange around the world. Whether you hail from Norway or Brazil or Texas, it makes no matter. Your gold will be good in any of these places and it’ll likely purchase you the same amount of assets.
Fiat Currency
When it comes to fiat currency, you’ll find that the word fiat has been added when an authoritative power has established a currency by decree. For instance, the U.S. dollar is a fiat currency. So is the Euro and the Yuan. These are currencies that have been deemed legal to use in certain situations. They’ve also been deemed to be worth a certain amount. An arbitrary amount, but an amount nonetheless.
Inflation & Deflation
Let’s talk about inflation and deflation for a moment. I can make this idea very simple for you. Let’s say that there were only one million dollars on earth, among every single nation. All we as a collective people had to spend was one million dollars among all of us. Essentially, we’d have to split that amount of currency up and each of us would get a slice of the pie and we’d be able to purchase things with our little slice. That one million dollars would have to cover the costs of pretty much everything we wanted to buy, from someone’s labor to a piece of land to a new car to a peach at the market.
Now let’s say that a new car costs $100. I know this isn’t accurate in accordance with my example above, but it’s a nice easy number to work with. With $100, any one of us could wander into a car dealership and buy a car with that amount of currency. That’s a very straightforward idea. Now, let’s pretend that one day, we woke up to learn that someone of authority had printed an additional one million dollars and had sprinkled it throughout the world. Now there were two million dollars for all of us to share. The thing is, that two million dollars would be used to buy the same amount of things we could buy previously. What we could buy hadn’t changed at all. The only thing that has changed is the amount of money each one of us held in our collective pockets to buy that stuff.
The question is, if you walked into the same car dealership and asked to buy the same car as before, how much do you think that car would cost? You got it – $200. It’s simple math really. The additional currency didn’t add any benefit to the economy. It actually added just the opposite. For those who held their little slice of what was previously available close to their hearts, they saw half of its value evaporate into thin air. That’s the beauty of inflation. It’s great for debt holders, but not so much for savers.
And just so you know, the exact opposite is true when it comes to deflation. When you deflate a currency, it becomes worth more, not less. So in cases like these, debt holders would lose while savers would win.
The Life Cycle of a Fiat Currency
I’m sure you’ve heard or read of the many examples of new currencies being created and old ones dying off. This type of thing has been a part of life since the earth was born. Here’s how it works. A bank (or government – I’ll get to the relationship between the two later on) creates a new currency that’s linked to an asset, such as gold or silver. It doesn’t need to be gold or silver, but those two are easy to understand. The government says, “We’ve got one one hundred ounces of gold, therefore we’ll issue one hundred paper dollars to put into circulation.” The gold will be stored in vaults while the paper is circulated among the populace to use for commerce and trade. It’s not a bad idea. Essentially, the paper currency is an IOU that indicates what it’s worth. Back in the old days, if you held paper currency, you could visit a bank to redeem it for its worth in gold or silver. This was commonplace.
The problem with currencies that are backed by physical assets is that they didn’t buy much. As humans, we always want more. Because of this, we’ve devised methods for severing the link between our currencies and whatever we had that was backing them. By doing so, we’ve been able to create more and more currency without anyone being the wiser. Creating currency has grown the economy and has led to a number of very positive developments. Many gold bugs are rabidly against debasing currencies (printing more money) because it goes against their arbitrary standard of purity. The evidence suggests though that the expansion of currencies has been quite beneficial in the 20th and 21st centuries.
Anyway, inevitably, what goes up must come down. Apparently there are natural laws of economics that can’t be bent without eventually breaking. As a currency becomes less and less valuable, it loses the faith of those who use it. Eventually, the population will turn to something else they deem valuable and the currency will be lost forever, no matter how much of it they’ve got stuffed in their pockets.
Who Does Fiat Currency Benefit?
This is a good question and to answer it, you need to know who’s in charge. I’ll give you a hint – it ain’t you and me. Let’s just say for now that it’s a combination of big government, big banks, and big business. The people who manage all of these things are good friends and they’ve figured out ways to make things work for themselves. Really though, I don’t want to seem ungrateful because by making things works well for themselves, they’ve also made things work well for us. We’d be nowhere without these people and deep down we all know it. But I digress.
If an economy has a specific amount of currency floating around it, all assets in that economy are worth the perceived value of that currency. If new currency is added to the economy, the assets change their value, but not immediately, and that’s important to understand. When new currency is introduced into an economy, yes, values of assets change, but only after the effect of that currency is felt. By that time, those who the currency is released to have already purchased a whole bunch more stuff with tomorrow’s money at yesterday’s prices. Get it? Over time, and as currency is perpetually released into the various economies of the world, those who it’s released to amass more and more wealth and become more and more powerful. This is part of the reason certain groups love national debt. They make a killing off of it, until, of course, the entire house of cards falls down. Eventually, all of that new currency erodes the value of the old and parts of the average Joe’s savings are confiscated. It’s almost as if the average Joe has been taxed without even knowing it. Now there’s a concept!
How Does Precious Metal React?
The world can get away with expanding currencies for a while. On average, it used to be that any strong currency would last around 100 years until its malfeasance caught up with it. Today, it’s lasting a bit longer. I don’t know why that is. Most likely because bankers and governments have become more clever in some way or another. Eventually though, the population that uses the currency smells the awful stench of instability and rushes towards something else that they perceive as value. Oftentimes, that something else is gold and silver. This fiat stench and precious metal cycle has been going on for thousands of years. As the rush to precious metals is occurring, you can only imagine what happens to the price of it. What was once priced at $100 an ounce shoots up to $1,000 an ounce. This only makes sense as everyone all of the sudden wants it. Simple supply and demand.
During this transition to precious metals from a failing currency, there are only a few things that can be done. One, the entity in charge can decide to once again back the currency with something of true value, such as gold and silver or they can allow the currency to be completely destroyed and lose value. And in doing so, anyone who holds it will also have their wealth destroyed. It’s not a pretty picture, unless you’re the one who noticed what was going on and decided to trade in some of your fiat currency for precious metal. Or real estate. Or food. Or anything else that’s actually worth something.
Well, I think I’ll stop there for today. Tomorrow, I’ll be writing a lot more and continuing this conversation about gold and silver. It’s all very exciting to me, so if you’ve got any questions, please ask down below. I’d love to help answer them.
Dutch Tulip Mania
I just finished reading the section in Guide to Investing in Gold & Silver about the Dutch tulip mania that occurred in Holland during the Dutch Golden Age and which collapsed in 1637. According to Wikipedia, it’s common for those in the know to call any speculative economic bubble where prices are greatly misaligned with an asset’s intrinsic value, “tulip mania.” I’m not sure the author, Mike Maloney, was trying to prove anything in particular by writing this section other than to demonstrate how utterly irrational human beings can become as it pertains to spending inordinate amounts of money for no other reason than perceived value. Here in the United States, we have plenty examples of our own speculative bubbles. Think about Beanie Babies. Think about baseball cards. Think about artwork. None of these things have any value other than what someone or a group of people have agreed upon. Even gold is speculative if you think about it. What value does gold or silver hold beyond what we perceive? People claim that it’s got real value. That it’s money. That it’s worth something. Is it? If the global financial system collapsed tomorrow and the entire planet of people began the process of starving to death, do you think gold would help? Would you eat the gold? Would gold save you from illness? I’ll tell you what would be a lot more valuable than gold. Land upon which to farm. Weapons with which to defend yourself, and food to eat. Probably some medicine too. It’s not rocket science. Yes, gold and silver are valuable as industrial necessities, but beyond that, any value we’ve attributed to precious metals has been completely arbitrary and within the confines of a fully functional monetary system.
Actually, I think Mike shot himself in the foot by writing this section. He sort of proved my point from above. We’re silly beings, we humans are.
Anyway, as I was doing my research for this post, I bumped into an article written in the Smithsonian Magazine that claims the entire tulip mania thing didn’t actually happen. I have no idea whether it happened or it didn’t, but I always love those who makes claims and counterclaims, as if any of us were there. History is full of fake new and made up stories to fit the narratives of whomever wrote it. Just think about the history of 2020 we’ll read in 50 years. Can you imagine what it will contain? Pure nonsense, that’s what.
For the sake of this post, I’ll give you a quick rundown of what occurred during this tulip bulb mania in Holland. In 1593, tulip bulbs began being imported into Holland from Turkey. Almost instantly, the bulbs were viewed upon as a status symbol and anyone with means simply had to have some. Because of this “mania,” the price per bulb exploded and ultimately (and allegedly) reached $1.8 in today’s dollars. Well, actually Mike’s book was written some years ago. I’m sure this price in today’s dollars will continue to climb. As I sit here any type, the Biden administration is planning a $1.9 trillion stimulus package. We’ll just have to see if that prompts any inflation. More on that in a moment. Anyway, once the population of Holland realized how silly they were being, the price of tulip bulbs collapsed in 1637. Tulips were once again priced much more rationally and as if they were only a flower.
I think proponents of the free market don’t like this story too much. They claim that it was the free market that allowed the tulip fever to fester and because it climbed so high and ultimately collapsed, the economy of Northern Europe suffered for decades. While I agree with them, I don’t see any other alternative. Certain constraints have been placed on markets before and it was actually those constraints that caused failure, so which is better? A free market economy or a command economy? I really don’t know.
Before I end this post, I’d like to quickly touch on the $1.9 trillion stimulus the Biden administration is pushing right now. I’ve been hearing from the Democrats that this is an absolute must and I’ve been hearing from the Republicans that it’ll put us into a tailspin with national debt and inflation. Which is it? I really don’t know, but I’ll offer you a perspective that’s rarely considered. It’s one of a global economy of which the United States and China are the two largest players. Basically, The U.S. is China’s biggest customer. If the U.S. has no money to spend, China’s got no one to sell to. Not really, but in simple terms. If this were the case, the two largest economies on the planet would nearly collapse, bringing the rest of the world with them. If you were part of the monetary and political policy machine, what would you do? After all, when recessions and depressions occur, deflation follows, not inflation. During this deflationary cycle, the adding of stimulus makes sense, not only for the United States economy, but for China’s and the rest of the world’s. So by adding another $1.9 trillion to the American economy, the Fed is actually adding this amount of money to the entire globe. People need to stop thinking on a national level. It’s disingenuous. This stimulus will be sliced up between 195 different nations and it’ll be barely noticed. We as citizens of this fine nation really have no idea how global banking works. We make many assumptions that simply aren’t true. Like the price of gold (and tulips), much of what we say is pure speculation.
What’s your opinion on the Dutch tulip mania issue? Also, what’s your opinion on the Biden administration’s push to add all of this additional money to the global economy? I’d love to know.
John Law & His Inflatable Currency
After you read this story, you’ll be scratching your head in wonder of how people get away with what they get away with. Here’s the truth about currency: if you have something of value and someone else has something of value, then the two of you can trade those two things of value with each other. If there are three or more people with things of value, trading becomes complicated. In cases like these, a trading apparatus such as a currency can be developed to ease the complication. But remember, the currency that’s introduced must hold an illusionary value only of the assets it represents. Additional currency can’t be introduced without producing negative consequences. Those negative consequences usually take the form of lessening the value of each piece of currency. If too much currency is introduced, those who use the currency for trade lose faith it in and seek out another trading apparatus they have faith in. And that’s the story. That’s it. Everything else just muddies the water.
Let’s talk about John Law for a moment. Apparently, this guy was the savior France was looking for for a good long while. It wasn’t until his ideas began to fail that he ran for his life and hid from those he was once a savior to. What a shocking and tragic story. How one of the most wealthy men in the world died penniless and alone is beyond me. There seems to be some sort of mental illness at play here. You be the judge.
John Law was born in Scotland and was quite intelligent. He was a whiz at mathematics. He was raised by a wealthy banking family, but due to his weakness for gambling, he managed to lose all his father worked so hard for. In England, he was tried and convicted of murder, yet escaped captivity and ran to Paris. While in France, John became friendly with Duke d’Orleans who eventually became king. France was huge in debt and when John Law introduced the idea of paper currency to the regent king, the king snatched the idea up and made it so. After the introduction of paper currency, France paid off all its debts and began spending like it was going out of style. John Law created a company and made it to the helm of France’s central bank. As time went on, the central bank printed more and more money and John Law issued more and more stock for his company. Eventually, a bubble formed for both the currency and the company. Everyone wanted a piece of both, which caused inflation. As soon as the more astute investors became aware of what was about to happen, they spent all their currency on hard assets, such as gems, gold, and real estate. Eventually, owning gold was outlawed and Law was fired from the central bank. He hightailed to Venice where he died a poor man.
To summarize the story (which I just did to the best of my ability), paper money was introduced into France’s economy. It wasn’t backed by any type of asset, giving the central bank free reign to print as much of it as they wanted. You see, when a currency isn’t backed by anything, there are no limits to how much of it can be printed. This is exactly where banks and governments get themselves into trouble. Think of the 2008 financial crisis. Banks loaned money to anyone and everyone, creating a huge credit bubble. Like all bubbles, it burst, leaving despair in its wake. In France’s case, the bank continued printing all the way to a place where the investor class realized that it wasn’t actually worth anything. They traded theirs for assets with actual value and left the rest of the country to deal with the fallout. This seems to occur quite a bit around the world. We’ve seen it time and time again. Apparently, it’s a joyride until you’re the one stuck holding the bag.
The primary difference between the credit bubble of 2008 and what happened in France was faith in the currency and military might. The U.S. dollar is backed by more than nothing. It’s actually backed by the fact that there’s nothing to take its place as well as its military. Wars are fought over currency. If the U.S. dollar ever inflated into oblivion, there would need to be a replacement, which as of this moment, there isn’t. Actually, I’m sure there is, but it just hasn’t been rolled out yet. Once it’s ready, you’ll see the U.S. dollar fall. And I’m sure it’ll happen on purpose. It’ll be sold as some sort of crisis, but like so many other crises, it’ll be manufactured. That’s the most effective method for getting things like this done around the globe.
Have you heard of John Law? What’s your take on him. For a few years there, people were living very well in France and it was his doing. I’m sure there are those who feel he was a great man. I’m also sure that you’ve read or heard a lot more about him than I have, so if you’d like to discuss it, please do down below.
Hyperinflation in the Weimar Republic
I read a book once about the Weimar Republic and its hyperinflation mess. Well, I guess I shouldn’t say I read the entire book. I got about half way through it and had to put it down. While the beginning was fun, the end turned into a real drag. I felt like I was back in finance class in college. Far too many numbers. It’s a shame I didn’t make it all the way through the book because the Weimar issue is a huge example of how a currency can disintegrate into nothing. There are many lessons to be learned through the story. Luckily, I’ve got a much more entertaining version that’ll be very easy to make it through. Mike Maloney broke things down in a straightforward way in this book called A Guide to Investing in Gold & Silver. The entire thing took be about four minutes to read. I’ll break it down below. And as always, if you’ve got any comments on it or any background information, please let me know.
Okay, let’s begin. If you’re familiar with the financing of wars at all, you know that when one occurs, the nations at war generally disassociate their currencies with gold and silver. It’s the only way they can finance the war they’re engaged in, other than taking on investors and many, many loans. They simply print money as they need it. And if you’re familiar with how wars are fought, many of them are games of attrition. It’s who can outlast who and since wars are all about currencies and money, if one nation (or group) can keep the war going long enough to collapse their enemy’s currency, they’ve won the game. It’s an interesting strategy and one we see played out in modern times. The Iraq war is a great example. For over a decade the Iraq no-fly zone forced Saddam Hussein to assign resources to essentially nothing. This wore the nation down and when it came time for coalition forces to move in through land and air, the Iraqi defenses were spent. Many people think that long term endeavors are wastes of resources and are for no reason. These long term endeavors are actually some of the most peaceful battles being waged.
Back to the Weimar Republic. During World War One, the republic unlinked its currency from precious metals and wouldn’t redeem their “money” for gold and silver any longer. It also printed four times as much currency as was in circulation before the war, during the war, but none of that additional currency was felt through inflation because of all the capital hoarding that was going on. Much like today, those who sense a rocky economy don’t spend their money. So no matter how much money gets injected into society, very little of it is spent. The reason so many governments offer stimulus to the lower portion of earners is because those earners will surely spend the money they receive. If government gave money to high income folks, those folks would immediately put it into the bank for later use. Saving stimulus money does absolutely no good if it’s saved. It needs to be spent. Even corporations today are hoarding cash. This type of activity creates a huge buildup of currency.
By the time the end of the war rolled around, people began feeling much better about their nation and about their economy, which prompted large amounts of spending. All their savings began pouring out from their bank accounts into every day life. Because of this massive injection of currency, inflation hit, driving up prices of precious metals as well as everything else. On average, prices rose from five to 20 times of what they were just a few years earlier. Those who responsibly saved their earnings felt the effects of this inflation the most. They lost most of their purchasing power through no fault of their own.
After a brief respite, inflation roared back into the economy in 1921 and 1922. Because Germany was forced to pay for war reparations with gold, silver, wood, coal, and the like, they continued to create more and more currency for their populace. The problem was, by this point, no one in the country trusted the currency at all. And because it was devaluing so fast, the moment someone got their hands on it, they spent it, which flooded the market with even more of it, making matters worse and worse. By 1923, Germany was printing 500 quadrillion marks a day. Yes, that’s correct. I had to read that one twice. Can you imagine a relatively small government, such as the German government, printing out that much money every single day? Apparently, there were 33 printing plants working round the clock to get this currency into people’s hands. But again, because no one trusted the marks, they got rid of them as fast as they acquired them. Their value was falling that fast. Because their value was falling, more and more were being printed. Do you see the problem here?
Here are some examples Mike gave about how much things cost in 1919 and then how much they cost in 1923. Check this out:
Shoes: 12 marks to 30 trillion marks.
Bread: 1/2 mark to 200 billion marks.
Egg: .08 mark to 80 billion marks.
Stock Market: 88 points to 26,890,000,000 points.
Even though the stock market screamed, it’s purchasing power had fallen more than 97%. I’ve read that one strategy to counter inflation is to invest in equities. This new information has given me pause. Although, I will say that today, we have an opportunity to invest in multinational corporations. I’m not sure what the German stock market was comprised of back then. The multinational thing might round things out via diversification, which would help.
By this point, you may be asking yourself if anything outpaced inflation. That’s what I was asking before I learned that yes, there was something. It was gold and silver. Gold grew from 100 marks per ounce to 87 trillion marks per ounce. Can you imagine owning ounces of gold while watching everything else burn down around you. But while the cost of gold grew exponentially, its value fared even better. The mark’s value had dropped 97% against gold.
Now, here’s how inflation works. We always knew this, but we are very slow to act upon it. Poor people don’t have much to lose, so they don’t feel the effects of inflation very much. If they’re on any type of government support, that support should match inflation. The rich know things the rest of us don’t know. They’ve got friends in high places and generally act before they are forced to, which makes them even richer. It’s the general citizen who gets crushed. Just think about it. If you had $200k sitting in a savings account today and hyper inflation hit, within a few years time, that 200k would be next to worthless. And you might not even have it anymore because after a year or so, you’d read the writing on the wall and get rid of it. What would you buy? Hopefully something that doesn’t squander it. Personally, I’d buy land, real estate, food, medicine, solar panels and batteries, and precious metals. Anything that has any amount of inherent value to it. The only problem with that strategy is faith. Since it’s been so long since something drastic has happened with the economy, we’d be very slow to change our ways. I think most of us can smell the fact that something’s on the horizon though.
Here’s an example from the book for you. In 1923, 25 ounces of gold had the purchasing power of an entire city block of commercial real estate in Berlin. That’s how much the value of gold increased compared to the currency the government was trying to pedal. I’ve read about similar scenarios in Venezuela. People buying cars and houses for just about nothing. Their currency is worthless as well. Anyone who thinks ahead and who’s strategic can make out very well during one of these crises. I’ll tell you this though, I certainly never want to feel the effects of a drastically devaluing currency. People starve to death during those times. They eat their pets. I’ve heard it all.
Mike Maloney says that during the worst kinds of economic crisis, wealth doesn’t actually evaporate. It merely changes hands. So if you’ve got tons of currency before hyperinflation and you decide to trade that currency for previous metals or real estate at the right time, you can make out like a bandit. The trick is to know the right time. I suppose this is why planned purchases of gold and silver are probably the best strategy one could follow. Yes, it’s boring and it’s expensive, but if you look at the value of your currency years into the future, you may be thanking yourself huge when those times roll around.
So there you have it. The story of the Weimar Republic. If this all sounds too out there for you, I suggest you do your reading. You’ll see that it’s all true. Actually, you’ll probably find out even more that’ll shock you. Financial crises are not good things. For some of us. For others, they can be very good things. I suppose a hint of paranoia wouldn’t hurt to kick us into gear.
The Decline of the Dollar
In this post, I’ll give you an outline of how currencies collapse and how that outline pertains to the U.S. dollar. After that, I’ll throw in some conjecture, simply because I can’t let a narrative stand without question of skepticism.
Okay, this is how it happens. This is how a nation destroys their currency. Keep in mind that in order for a nation to develop a currency in the first place, it needs to have something of value to back it. It’s almost like a loan to the populace. A group of people who live in an area of land can’t simply make a currency out of nothing. No other nation, and probably no one inside the nation, would take it seriously. What’s it worth and why is it worth something, they’d ask. That answer better have something to do with collateral. If huge investors called a nation on their bogus currency and wanted something of actual value, what could they take? That’s the collateral I’m referring to. If nothing is there, investors won’t invest.
So, in general, this is how these things play out:
1. A nation, nations, or group of people initiate a currency that’s of value itself or backed by something of value. It doesn’t necessarily need to be backed by gold and silver, but that would be nice (and transportable). The reason for the backing is the collateral I referred to above as well as a limit to the amount of fiat currency that can be produced.
2. As the area develops, it decides to, for whatever reason, offer layers of entitlements and welfare programs to its citizens. When you see a once proud and vibrant nation begin social programs such as welfare and universal health care, understand that it’s in the second stage of destroying their currency. What’s worse is that most nations don’t even print their own currencies. Their central banks do, which aren’t even part of the government.
3. Because of the expanded economy of the nation or nations in question, the military grows as well. The military is the ultimate in social programs as it sucks up the most money.
4. Once the military is large and powerful enough, wars begin. That’s when the money printing and debt really begin. When you see a nation starting wars to expand their sphere of influence, understand that the nation in question is in stage four of destroying their currency.
5. As the wars continue, the money printing and debt continues as well, driving up the amount of currency that’s in circulation. Essentially, what’s happening is that every additional piece of currency that’s printed destroys the value of what’s already in people’s hands.
6. When the printing hits a certain point and people begin to feel the effects of the devaluation and inflation, the populace and the investor class loses faith in the currency altogether.
7. Because of this loss of faith, most people don’t want to trade with the currency at all. Or, they still want to trade with it until it’s all gone out of their hands. What they buy with their dying currency is usually things of real value, such as hard assets (land, oil, gold, silver). And once the process of getting rid of as much currency as possible is complete, the currency collapses and the transfer of wealth would have been finished. Losers lose big and winners win big.
I’d say we’re all rather complacent to the effects of inflation here in the United States. It’s generally not something we need to concern ourselves with because we haven’t felt any dramatic effects of it for decades. Actually, the last time I can remember experiencing big inflation was the 70s into the 80s and then some minor inflation during the turn of the century. You can always tell when there’s inflation by looking at the interest rates banks are willing to pay. Or, the interest rates you have to pay on loans. Back in the early 80s, people were paying 16% on mortgages. And in the year 2000, I was getting 7.5% on some CDs I owned. We haven’t seen those types of numbers in years, so we don’t think about this type of thing very often. Keep your eye on the government though. Have they released any big chunks of stimulus lately? Have businesses been hoarding their cash? Actually, big multinational corporations have been hoarding cash for over a decade and just recently, the U.S. has offered gigantic stimulus packages to anyone and everyone who will take the money. I wonder what type of effect those two things will have once inflation begins to kick in. Remember, when people and businesses sense inflation, they begin to spend to get rid of their money, which only exacerbates the problem. Eventually, it’ll all be gone and we’ll be wondering why we didn’t pay more attention to this type of thing more in the past.
The number one area of concern regarding any election should be financial prudence. If you ever hear a politician tell you that they are going to spend money on this or that, or on you, for that matter, show them the door. Nothing else matters in politics. Only financial policy. All else rests upon a healthy and functional government. Not a soul on earth will care much about social issues or someone else’s rights if they’re starving to death. Trust me.
Up next, I’ll talk about the gold standard and the Fed.
PS – I almost forgot my conjecture. Basically, I wanted to say that in order for a currency to collapse, people and business need to spend all the currency they have, which will really get the ball rolling. My question is, what if the population doesn’t actually have any money? What if a nation’s people are so in debt, they’ve got nothing to spend? Have the banks figured it out? Have they figured out how to avoid hyperinflation? Simply figure out a way for most people to live off of credit, thereby avoiding the spending frenzy that usually precedes the crash? I wonder, because the U.S. is a very indebted nation. Most people couldn’t spend money if they wanted to. It’s an interesting thought.
How the Federal Reserve Began
I’ve always been fascinated by certain aspects of history. No, not the boring parts, but the much more entertaining and telling financial parts. Believe it or not, most of history was spurred by financial interests and most of those interests have never been described, much less mentioned. That’s academia for you. Cherry picking what they want to tell. There’s a lot of history out there that’s disingenuous at best and flat out false, or shall we say, not very complete, at worst. I’ve seen history written in my years on this planet and it ain’t pretty. It’s actually really bad. I can’t believe people teach much of what they teach.
Anyway, one of the most consequential pieces of history to have ever occurred, occurred on Jekyll Island, Georgia. I’ve actually read about the bill that was written to create the Federal Reserve system a number of times. I take everything that was said with a grain of salt because it’s full of drama that simply doesn’t need to be there. For example, take a look at this excerpt written by B.C. Forbes of Forbes Magazine:
Picture a party of the nation’s greatest bankers stealing out of New York on a private railroad car under cover of darkness, stealthily hieing hundreds of miles South, embarking on a mysterious launch, sneaking on to an island deserted by all but a few servants, living there a full week under such rigid secrecy that the names of not one of them was once mentioned lest the servants learn the identity and disclose to the world this strangest, most secret expedition in the history of American finance.
I mean, c’mon. Do we need adjectives and adverbs like: greatest, stealing, private, cover of darkness, hieing, embarking, mysterious, sneaking, deserted, rigid secrecy, strangest, secret, and expedition? It’s almost like watching one of those “documentaries” that’s full of ominous music playing quietly in the background. It’s almost as if the setting is meant to persuade the reader or watcher into believing something, simply because the story isn’t that interesting in and of itself. It’s like English politics where they call everything a “scheme” that they don’t like and a “plan” that they do. Give me a break.
But much of what I’ve read I believe to be true. Never mind the drama. Let’s look at the facts as they’ve been described:
– From 1871 through 1914, there was a balance of no monetary inflation at all. This was due to most of the world having their currencies linked to gold, or otherwise known as being on the gold standard.
I need to break in here for a moment. I’d like to talk about how trading occurred under the gold standard. Basically, when one nation has its currency pegged to gold and others do too, those multiple currencies are essentially linked to one another. Trading is fair because all parties involved know what the costs will be far ahead of time. Also, each party is confident in the other’s worth because of the currency being linked to gold and silver. Part of the reason having a groups of nation’s currencies linked to gold was beneficial was because of the parity the system created. Think about it this way: when one economy did well, the people of that economy spent their money. This was akin to gold leaving their economy toward other economies, creating less spending power for the first economy. Because of the lack of spending power, the initial spenders became less wealthy, creating less demand. And because of that lack of demand, the economy of the spenders suffered, driving down prices. When prices fell, demand from others rose, resulting in an influx of currency and wealth. This cyclical pattern repeated itself over and over through the years and worked very well. Sure, you’ll read about various crashes and the like, but if you dig a bit deeper, you’ll discover that most, if not all, of those crashes occurred because of bankers and speculation.
Okay, back to the facts:
– During the years of the gold standard, actual gold was stored in the various nations’ treasuries. Any currency that was printed was linked to the amount of gold that was stored.
– The Federal Reserve is not a government agency.
– The Federal Reserve has stockholders and is a private corporation. It pays dividends to those stockholders.
– The Federal Reserve has no congressional oversight. It can print money (offer debt) as it sees fit. It also can not be audited by anyone.
– In 1907, there was a stock market crash called the Panic of 1907. It was alleged that Wall Street was causing crashes and buying stock on the cheap when unsuspecting businesses and individuals sold theirs out of fear. Wall Street would later sell these purchases at a profit.
– In 1908, congress created the National Monetary Commission to study the crashes and to devise a way to fix the problem. Senator Nelson Aldrich was made chairman of the commission.
– The senator visited Wall Street as well as Europe and gathered some of the world’s wealthiest banking men to devise a strategy for fixing the stock market crash situation. The problem was, the men he gathered were suspected of being the ones who caused the crashes in the first place.
– In 1910, these men (Paul Warburg, Abraham Pete Andrew, Frank Vanderlip, Henry P. Davison, Charles D. Norton, and Benjamin Strong, among others) met on Jekyll Island for a week to hammer out the details of a new private corporate bank that would assume the responsibility of handling the United States’ economy.
– The plan these men devised was called The Aldrich Plan. It didn’t pass congress in 1910, but was renamed The Federal Reserve Act and was passed in 1913.
– It was at the moment of this plan’s passage that the United States handed over it’s authority to mint its own coin and control the value thereof to a private bank.
And that’s it in a nutshell. Think what you want of the Federal Reserve Act, but when you do, remind yourself that you’re likely reading this post on a mobile phone or a computer, neither of which would probably be in existence if we had a currency bound by gold. Gold purists love to spout their adoration of precious metals because it keeps people honest. But think about this: how is an economy supposed to grow if there’s a limited amount of financial resources? How were we supposed to put a man on the moon? How was the Large Hadron Collider supposed to be built? How were the COVID vaccines supposed to be paid for? And also think about this: how would developing nations or nations that have no gold ever develop? Things are much more advanced these days and it’s not out of the realm of possibility that a fully detached currency can do the job very well. Actually, that’s fairly obvious if you look at the last 100 years. Yes, there have been problems, but most of those years have been great, financially speaking. And most importantly, remember this: all currency is backed by something. It never gets printed without being linked to some sort of asset. So if the Federal Reserve loans the U.S. government trillions of dollars, don’t think for one moment that it does so for free. Remember, the Federal Reserve is a bank. It’s there to make money. If the government fails to pay, the Fed will take its collateral, whatever that may be. If you’d like to know more and learn about the theorized collateral, I suggest you read The Creature From Jekyll Island.
So there it is. The shortest version of how the Fed was created that you’ll ever read. What’s your opinion on all this? I’m in no way a Fed hater. I actually like the fact that what was once thought of as an economic law has been beaten. That’s not to say that there won’t be tough times in the future due to some weird crash and “solution,” but for now, people are able to take out very cheap loans to buy their dream houses. That wouldn’t have been possible with the gold standard.
What is Fractional Reserve Banking?
The Federal Reserve is an extremely interesting bank. It’s a fascinating organization that does fascinating things. I’ve always been interested in how certain people create certain things and keep them operational. I’ve also always loved learning about different business models. It’s the latter I’ll discuss in today’s post. Read on below because you might learn something you never knew. And you might love it as much as I do.
The Federal Reserve bank was created in 1914, after the Federal Reserve Act was passed in 1913. The bank took over the currency creation responsibilities from U.S. government. The U.S. government no longer prints money. The Federal Reserve does. That’s why you’ll see “Federal Reserve Note” printed on the cash in your pocket. The way the bank primarily “prints money” is through the issuance of loans. So basically, here’s how it works. The U.S. government needs some money to cover its expenses. Since the money they need isn’t in circulation, they turn to the Federal Reserve. With the press of a button, the Fed fills the U.S. treasury with a set amount. That amount is equal to the loan amount. So in case you weren’t aware, the U.S. government borrows the money it needs from a private bank. Now, this is where it gets interesting. Every dollar the Fed loans, they do so with interest. So if the Fed loans the government one million dollars at 3% interest, that’s what the government needs to pay back. Since its inception in 1914, the Fed has loaned money to not only the government, but to all sorts of institutions as well. Each and every one of these organizations owes the Fed what they borrowed, plus interest.
I want you to read those last few lines again. Yes, the Fed loans these organizations money at interest. If this is the case, how in the world would the U.S. government and these organizations ever pay the Fed back the entire amounts they borrowed? After all, the Fed has loaned all of the money the government has ever used. If interest is to be paid on the loan amount, where is the government supposed to come up with not only the principle, but the interest as well? Here’s the answer – it’s not possible. It’s theorized that as the monetary supply grows and as governments and organizations around the world begin to default on their loans, the banks will begin taking assets from these nations. Assets such as land, bridges, highways, tunnels, ports, etc…
To pay back the interest that’s owed, more money needs to be borrowed. It’s actually impossible to pay back the debt because the debt keeps on rising in order to pay back the interest on the debt. Now that’s a business model I like!
What’s better is this: when the Fed issues loans, they do so with nothing backing those loans up (as far as I know). They can issue them from what people love to refer to as “thin air.” After the loan is issued, the borrower must pay the loan back, plus interest. If the borrower can’t pay it back, they must pay some collateral and that collateral is what I just mentioned above. So as you see, hard assets aren’t necessary to issue the loans, but there may come a time (if not already) that hard assets are required to pay back the loans. This is how real wealth is created. Through hard assets.
Now, to be fair, neither I nor anyone I know is on the inside. We don’t really know how any of this works. Borrowers all over the place get away with defaulting on their loans and never paying any collateral. So yes, currency does just disappear and never gets paid back to the lending institutions that lend it. Without additional debt, the economy shrinks and no one wants that. So while we all like to beat up on the bankers, they’re the one who are making our lives so cushy.
Fractional Reserve Banking
The idea of having banks reserve a certain amount of currency on hand has been changing over time. Banks used to have to hold a percentage of all deposits on hand to use for withdrawals. This amount is referred to as their reserve requirement. If $1,000 was deposited on the very first day a new bank opened its doors and if the reserve requirement of that bank was 10%, that bank would need to keep $100 on hand for withdrawals and would be allowed to loan out the remaining $900.
It gets a little confusing here. When it comes to lending, the bank doesn’t actually lend out the $900 that was part of the $1,000 that was deposited. The $900 is borrowed from the Federal Reserve to lend out. So the Fed loans the money to the bank at interest and the bank loans the money to the consumer at interest. The $900 that the Fed loans is borrowed into existence. That money never existed before. When a consumer borrows that $900 from their bank, it usually gets deposited into another (if not the same bank) bank account somewhere. Once that deposit is made (wherever it may be), the bank it’s deposited into now has a new deposit, which it’s allowed to lend 90% of. Do you see the cycle here? Let me give you an example.
Jake and Sally want to buy a new house. The house costs $300,000, so they go to their bank to borrow some money. The bank borrows the money from the Fed and lends it to Jake and Sally. Jake and Sally take the money and pay for their new house with it. The seller of the house takes the payment and deposits it into their own bank account. The bank in which this new money is deposited says, “Ooh, we get to make new loans now!” and lends out 90% of that deposit amount. If you’ve ever wanted to know why banks offer savings accounts and CDs, this is why. They want to have as much an amount of currency stored in their banks so they can lend out more and more at interest. It’s like a giant merry-go-round.
The Income Tax
What’s the biggest payer of the interest on the national debt? Yes, you guessed it. The income tax. Before 1914, there was none, but after 1914 (1913, really), the Sixteenth Amendment to the Constitution was added, which created the income tax both you and I love so much. Apparently, the U.S. government didn’t make enough in revenues to cover the interest on the debt.
Again, this isn’t meant to beat up on anyone. Debt is necessary for growth. Everyone knows this. Without debt financing, we’d live in a stagnant world that wouldn’t be nearly as advanced as it is today. Covering the income tax is a very small price to pay for all that’s come out of the debt we’ve incurred through the ages. We’d likely have very few vaccines, houses, parks, airplanes, etc…without any debt. What I’m sharing here is merely some simple history.
Passed by Congress July 2, 1909. Ratified February 3, 1913. The 16th Amendment changed a portion of Article I, Section 9
“The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”
What Was the Gold Exchange Standard?
We all know that wars cost a lot of money, but what we all don’t know is how that money is created and what that money creation does to banking and the fiscal policy of a given country. I’m continuing on with reading Michael Maloney’s Guide to Investing in Gold & Silver and have made it to the chapter called Greed, War, & the Dollar’s Demise. Before I go any further with this post though, I want you keep something in mind as you read what I have to say below. I’d like you to remember that while someone usually loses in the world of high finance, someone else usually wins. It’s what we like to call a zero sum game. Your loss is my gain. The two balance each other out. So while you read that there was rampant money creation at some point in history and that money creation partially severed the link between the dollar and gold, ask yourself who the winners and losers of that were. Ask yourself who the winners and losers are in all things related to banking and politics and you’ll come to learn a great deal about this world. Remember, most large scale events don’t just “happen.” They’re usually orchestrated. Pay close attention to what occurs after those events have come to close. It’s striking what you can uncover.
Let’s get into World War One. In general, the nations that were battling one another spent like it was going out of style. They stopped allowing the redemption of their currencies for gold, printed money like crazy, charged their citizens and importers much more in taxes, and borrowed money from anyone and everyone who would lend it to them, including the citizens of those nations involved, foreign governments, and international and national banks. It was a very messy scene and much of Europe was in financial disarray when all was said and done.
While the United States wasn’t directly involved with the war effort for its first few years, it did play a huge role in the manufacture and shipment of supplies to those who needed them. The U.S. charged those nations for those supplies and because of that, its coffers were rather full of gold. So while there was a huge export of gold throughout Europe, there was a huge import of gold in the United States. What did those nations do when they ran out of gold, you ask? Well, the U.S. loaned them money to pay for more supplies. So right here, we already have one beneficiary to one small part of the war.
When the U.S. finally did join the war effort, it too spent mightily. The U.S. national debt exploded 25 times its original amount from one billion dollars to 25 billion dollars. Who loaned the nation the money? I can’t be sure because Michael Maloney failed to mention that, but since the Federal Reserve had already been formed and since it loaned dollars to the U.S. government, I’d say it was them. And as we’re already aware, the Federal Reserve is a private bank that loans the United States money at interest, I’d say we’ve just uncovered another beneficiary.
Let’s be clear – the Fed was loaning money to the United States to fight the war, but the United States was still loaning money to its allies. So to say that the rising national debt of the U.S. was a bad thing would be somewhat disingenuous. It’s not like the U.S. spent all the money it borrowed. I guess you can consider it somewhat of a pass through entity in regards to borrowing and lending. Also, I wonder what the terms of joining the war were. Nations don’t just go in for nothing. Did the United States charge its European allies for its effort and for all the costs it incurred? I think that’s something we mere mortals will never know.
After the war was over, most countries agreed that being on the gold standard was better than having total fiat currency. Economies and currencies were more stable when they were backed by something of real value and those who traded internationally appreciated having trust in the various currencies in which they traded. Because of this, there was an effort to return to something that seemed like the gold standard. You need to remember, because so much money was printed all around the world during the war, if a return to the traditional gold standard – the one the world used before the war – was implemented, a massive devaluation would have occurred. Governments and banks don’t like to lose money, so they figured out a better solution. Or, something that seemed better, anyway.
Because the post war global reserve currencies were the U.S. dollar, the British Pound, and gold, that’s what central banks around the world held in their accounts as reserves. But since a unit of the dollar was in no way redeemable for a unit of gold any longer (the way it used to be), the idea of fractional reserve banking was born. It was actually born before this time, but was put into action on a large scale at this point. Simply put, the idea of fractional reserve banking means that by holding only a fraction of what was once redeemable for a dollar in gold, the bank can print or lend out multiples of dollars based on the amount of gold it held. So before the war, if a bank held one ounce of gold and was allowed to lend out one dollar (I’m making these numbers up), after the war, if they held one ounce of gold, they were allowed to lend out ten dollars. This was a great way to maintain the appearance of having a currency that was still backed by gold. It was also a great way to keep all of that currency floating around in the global economy. To learn more, check out the post on fractional reserve banking.
While this new “gold standard” doesn’t seem terrible on its face, it didn’t stop there. The problem was, the Fed abided by this standard, but so did commercial banks. Actually, commercial and foreign banks abided by a system that was similar, but not the same. They abided by a fractional reserve system, but not one that was based on gold. They based their fractional reserve system on U.S. dollars, which were backed partially by gold. So if the Fed was allowed to loan dollars based on a fraction of the gold that was held in the U.S. treasury, all of these other banks were allowed to loan money that was based on a fraction of U.S. dollars. You can imagine how many dollars and other currencies around the world came into existence by basing their loans on fractions. The entire operation morphed into a giant cycle of money creation. Ultimately, one $20 gold coin turned into $1,250. Talk about inflating the currency supply! And that, my friends, is what the gold exchange standard was all about. People certainly love money, don’t they.
How Does Credit Affect the Economy?
Have you ever thought about what a credit economy is? I’m currently reading “The Rise of Credit Culture” section in Michael Maloney’s book titled, Guide to Investing in Gold & Silver. It’s an interesting section that got me thinking about how beneficial, yet dangerous, credit can be.
Back in the days before the Federal Reserve was created, credit was very limited. It was primarily given to commercial enterprises, such as corporations and farms. It mattered who credit was offered to because the loan was very real. You need to remember that back then, currency was linked to actual gold holdings. If a borrower didn’t pay their loan back, another organization suffered.
After the Fed was born, credit flowed much more freely. Part of this was because of how currency was created. During these times, the U.S. dollar was less linked to gold than it had ever been, so the offering of credit to those who needed or wanted to borrow was less risky to any given enterprise. The problem was, with the onset of credit came the onset of borrowing. And borrow they did. People were taking out loans for cars, houses, businesses, and stocks. Yes, they’d even borrow money from banks to buy stocks. As you can imagine, because of all this lending and borrowing, bubbles emerged. And with every bubble comes a burst. So back then, not only did loans for stocks cause credit bubbles, they also caused stock market bubbles. You know, for people who seem to be so smart, bankers aren’t at all at times. Unless, of course, they know exactly what they’re doing. But that’s another post for another time.
If you think about it, the entire idea of credit is sort of like a pyramid scheme. In order for the system to be maintained, more and more borrowers need to come forth to build upon the currency that’s already been loaned out. And if the borrowers get spooked and don’t want to borrow, guess who does? That’s right, governments do. In our case, that would be the U.S. federal government. In today’s world, think about the COVID crisis. Consumer lending crashed during this time, but government borrowing didn’t at all. As a matter of fact, U.S. government borrowing has reached a peak not seen since World War Two. All this borrowing makes me think sometimes. How will we as a nation pay all this money back? Who loaned it to us? What if it’s not paid back? What happens then? These are all valid questions and they really should be top of mind for every American. I’ve said time and time again, the one and only issue that American’s should be concerned with is national debt. If there was no debt, any other social program could be easily paid for. Also, one day, this debt chicken will come home to roost. It’s then when most Americans will care less about the social issues they enthrall themselves in today.
According to Mike, the credit economy is all about people’s perceptions. If the economy is steaming ahead, people will borrow and spend. But if the economy begins to falter, people will run off and hide. The last thing they’ll want to do is borrow and spend when there’s a lousy economy around them. And on top of that, as the economy weakens, banks aren’t particularly fond of lending either, even though that’s their business. The whole thing makes me feel like the credit economy is built upon a very weakly constructed house of cards. The more we as a nation borrow, whether it be consumer, commercial, or national, the weaker we as a nation become. And if you’ve ever taken notice, it’s during our financial crises that most structural change occurs in the governmental and financial arenas. I’m telling you, one day, a big collapse is going to occur and the “only way we’re going to solve it” is if we fundamentally change our nation. Of course, it’ll be for the worse. We need to stop borrowing all over the place. No more personal, business, or governmental.
How do you feel about credit? Which is worse, national debt or personal debt? Do you think another collapse is on the horizon? If so, how do you think that’ll affect us? Let me know down below.
What Causes an Economic Depression?
It’s really not a complex concept. If we compare the national or global economies to a very localized one or even an individual’s finances, things become clear rather quickly.
Let’s say that you’re living in a time when a pack of bubble gum costs $1. You’re a kid, so your primary job is mowing neighbors’ lawns and shoveling their snow. Because you earn so much money doing these things, you’re able to buy a lot of bubble gum. The more you buy, the greater the demand for the gum, the higher the prices go. This type of thing is healthy (in moderation) for a well functioning economy. Now let’s say that, for whatever reason, half of your customers don’t want you to do their work for them anymore. Because of this, you only earn half the money you used to. Because you’re not earning that much, you don’t buy that much gum. And because of that, the price of gum stays stagnant. And because of that, the guy who sells the gum (your neighbor) stops paying you for mowing his lawn. And because of that, you can’t buy any gum at all, causing a massive price drop. And because of that fall in gum prices, the guy who sells it is forced out of business, compounding the problem all over the place. You get the idea. Depressions spiral down and get worse and worse as more people are affected by them. Essentially, depressions are caused by falling prices (deflation), which are really just a symptom of a contracting money supply.
Do you remember the economic crisis of 2008? Do you remember when Fed Chairman Ben Bernanke said that the problem with the depression in the 1930s was a lack of money supply. In the 2000s, he injected so much money into the world economy that he earned himself the name of Helicopter Ben, because it was like he was dumping money from a helicopter. The run up in the stock market for the past ten years has been partly because of this money dumping. Hint, hint – today’s money supply expansion puts the one from 12 years ago to shame. Should you invest in stocks today? Yeah, I think so.
Anyway, the way money is created in the first place is for an individual, couple, or an organization (a business, state, or a country) to take a loan from a bank. That loan creates new money. I know, it’s tough to wrap your head around. Let me put it this way. If there were only two people in the world and between them, they had $100, there would be just $100 in the world economy. Let’s pretend that one of those people walked up to the other one and said that he would like to borrow another $100. If the first person turned around and somehow printed that second $100 and gave it to the second, there would then be $200 in the world’s economy. Really, that’s how it’s done. It’s that simple.
Now, let’s continue on using the two person example. Let’s say that one of the people in this story starts to get nervous because of some sort of economic unrest. Perhaps he’s having trouble getting supplies to make his products or something else like that. Because of this nervousness, he takes his portion of the money and hides it under his mattress. Because this money is being saved or hidden, or whatever you want to call it, it essentially shrinks the available money supply in the entire world. If both people were to get nervous and do this, the available money supply would dwindle to nothing. That would cause real problems.
Now, I want you to notice how I used the word available in the previous paragraph. Money that’s sitting in people’s bank accounts and not being spent is useless to an economy. One of the things that makes recessions and depressions worse than they need to be is the hoarding of cash. Individuals and businesses do this when they become concerned. Actually, right now in the world, corporations large and small are sitting on piles of cash sitting in their bank accounts. It’s not having money that helps an economy, it’s the spending of money that does. It’s the velocity of the money that flows through an economy that helps things along.
If the Federal Reserve printed $100,000,000,000,000,000 right now and then parked all that money in an account somewhere and did nothing with it, would it have any effect on the national or global economy? Nope. Not at all. Now, if they printed all that money and gave it to the poorest of the poor around the world, would it have an impact? Absolutely. Those poor people would spend it immediately and prices would go through the roof for the products they like to buy. There would be so much competition to buy certain things that bubbles would form and there would be an entirely new set of problems. Sort of like when people try to buy snow shovels during a snow storm. We’ve all seen how that turns out. But you see how it works. Money that doesn’t move doesn’t help an economy. It’s the money that moves that does. This is why governments like to offer stimulus payments only to people who earn less than a certain amount per year. The governments know these people will spend it and that’s what they want. Well off people don’t spend their money; they save it. And that’s useless when it comes to sparking an economy back to life.
A lot of people wonder if money can just go away. If it can evaporate. The answer to this is yes, it can. Money can simply disappear. The times we’re living through right now are a perfect example of that. I’ll explain. Because of COVID-19, many people can’t pay their rent in apartment buildings. Because of this, they’re asked to move out. After they move out, no one else can move in because so many people are losing their jobs. These new people can’t afford the rent. Since there are no new renters, landlords are forced to reduce the rent they seek. Because of this, some new tenants move in. The landlords are now operating businesses that are not making nearly as much as they used to. If they tried to sell the buildings, they’d only get a fraction of what they would have gotten if there was no pandemic and if no one was losing their jobs. So if the buyer of the building took a loan for the purchase, it would be smaller than otherwise. Take this example and spread it over all aspects of the economy and you’ll see how dramatic it can become. It’s for this very reason that governments all over the place are giving people stimulus checks. So the money supply around the world doesn’t contract. If no stimulus was given, a deflationary effect would spiral out of control and there would surely be a depression as a result.
On the face of it, economic stimulus seems like a great idea during recession and depression. The questions that begs to be asked is, are there any negative effects? The answer to that is a resounding yes. First and foremost, the money for economic stimulus comes from the Federal Reserve, which is a privately owned bank. It’s loaned to the United States government at interest. As this happens, the national debt grows. And grows. And grows. We all know what happens when debt grows to the point of being unmanageable. I don’t even want to think about that. Collapses of governments happen, that’s what.
Second, with the influx of money, the economy begins to look good again. There’s a renewed confidence, which creates spending. Because of the confidence, all the people and businesses who were hoarding their cash begin to pull it out of their accounts to spend it. That’s a lot of money on top of the stimulus and regular gyrations of the already existing economy. The increased spending creates bubbles and inflation. If there’s too much money supply released into the economy, something called hyper-inflation is introduced, where people begin to lose faith in their currency. That’s when currencies collapse, which is akin to a collapse caused by debt.
As you can see, dealing with currency introduction during recession or depression requires a delicate balance. Too much or not enough can be devastating. No matter how you look at it, reacting to these types of things is rarely good, so avoiding them is better all around. The debates that arise are centered around how to avoid them, but that’s a post for another day.
Bank Runs & Deflation
If there was ever a perfect example of how bank runs can exacerbate deflation, the Great Depression was it. During no other time in American history did so much currency leave the banking system. To understand how and why this happened, we’ll need to look at how banks function and a bit of history.
It’s widely known that money that doesn’t move, doesn’t do society any favors. If money is stored in the banking system, at least the banks can use it to make loans. Money that’s sitting under someone’s pillow at home though – that’s something different. Since it’s not stored in the system, it can’t be used for anything other than making purchases. And if it’s not purchasing anything, well, it’s just useless. Let me explain.
With fractional reserve banking, if a person deposits one dollar in their bank account, the bank considers the deposit a liability; it’s got to eventually pay that dollar back to the person who deposited it. It doesn’t matter if it’s the same day or in ten years. It’s considered a debt to the account holder. At the same time, however, after the bank creates the liability entry, it also creates an asset entry. Because of the rules of fractional reserve banking, the bank is allowed to lend out $9 for every $1 it takes in. So if I walked over to my bank and deposited $1,000, the bank would have the authority to loan out $9,000 immediately, based on my deposit.
This type of thing usually isn’t a problem. During times of a well oiled and fully functional economy, banks can loan without hesitation or question. Because there are so many deposits and withdrawals every single day, the amount of money needed and loaned usually balances out. There are times when issues arise though. Let’s look at what would happen if a bank run occurred.
Bank runs take place when bank depositors get nervous about their nation’s currency. For whatever reason, people rush to their banks and make massive withdrawals. If enough customers do this in a short period of time, it can be catastrophic for the individual bank involved as well as the banking system overall. Why? Think about it. If $1 deposited can create $9 of currency in the form of loans, what happens when $1 is withdrawn? You got it, bank reserves need to be tapped to cover that amount of money. And if there are enough withdrawals and the reserves are used up, bank loans need to be liquidated. Back during the Great Depression and more specifically, in 1931, bank runs were overwhelming the banking system in the United States. So many people were withdrawing their money that a vicious cycle took place in the form of a currency collapse. Also, because so many people in the U.S. has deposited a good majority of money in their bank accounts, when it came time to run to the bank for withdrawal, much more came out than had ever before. It was almost as if all the trust banks had sold to the public ultimately became their undoing. During the Great Depression, bank failures were commonplace. In one month alone at its peak, over 350 banks in the United States failed. This number was on top of all the hundreds that had already and would eventually fail. The tragedy was, when a bank failed back then, depositors lost their money – for good. It was just gone. There was no federal insurance to protect anyone. So if a family had deposited 50 year’s worth of earnings into a bank and that bank failed, that 50 year’s worth of earnings evaporated. This was part of the reason so many folks rushed to pull out their deposits. They’d have to be stupid not to. And again, this type of behavior is what made the entire problem worse. A vicious cycle indeed.
So much money had flowed out of bank deposit accounts during the Great Depression that only a small fraction of it remained at the end. So, as they say, the more currency that flows through an economy, the more the level of inflation of the currency. The less currency, the less inflation. If the currency falls to rates that are low enough, deflation sets in. During the late 1920s and early 1930s, deflation had certainly set in. Things were not good at all.
It’s often wondered why the Federal Reserve pumps so much currency into today’s economy during times of recession or potential recession. It’s exactly because of what has transpired in the past. While no one (normal) likes more national debt, to some, it’s the only way to stave off a deflationary spiral. Have we had any instances of potential deflationary spirals in recent history? Think 2000, 2008, and 2020. If money hadn’t been pumped into the system through many different arteries, times would be drastically different. The area of concern revolves around whether the medicine was worse than the disease though. What effect would all this additional debt and market intervention have? Only time will tell.
Executive Order Banning Gold Ownership
Imagine this: you own a bunch of gold coins. Perhaps your father or grandfather gave them to you. Whatever the case, they’re your private property and they were lawfully obtained. Essentially, they’re no one’s business but your own. All around you, economic chaos is erupting. The dollar is being viewed with skepticism and deflation is taking root. People everywhere are closing out their bank accounts and hoarding their cash. Around the country, faith is being lost in the money we use every day. The only thing that gives you comfort is the fact that you own your gold. If push comes to shove, you could either trade that gold for whatever the dollar is currently worth or you could trade it for something you need, such as food, clothes, house, etc…
Now imagine that you wake up one morning to learn that your government just made gold ownership illegal and it ordered you to hand any that you currently have in your possession to the Federal Reserve, a privately owned bank. They’ll give you dollars for it, don’t worry. The same dollars that are crashing around you and that people are losing faith in. They tell you your gold is no good and that it’s not real money, yet they take it from you. Why? Because they want to. If you don’t hand over your private property, that act will instantly make you a criminal. Welcome to the USA in 1933. This is exactly what happened when President Franklin D. Roosevelt signed Executive Order 6102 on April 5. Pretty crazy, huh? Talk about a transfer of wealth from the poor and middle class to the rich. Somehow, someway, someone just took something that didn’t belong to them and it was completely legal.
Before this, the president also signed a bunch of executive orders that closed the banks for a “holiday” and upon reopening, forbade them from giving out gold in return for Federal Reserve notes. And after this, he signed some orders that forbade citizens from moving their money out of the country and from trading foreign currencies. And nearby, congress received an amendment that reduced the gold value of the dollar by 50% and that gave Federal Reserve notes full status as lawful and legal money.
What’s even more interesting is this: have you ever heard of the “gold clause”? I’ll need to tell you what this is so you can appreciate everything that occurred back then. During the Civil War, President Abraham Lincoln introduced a new fiat currency called the “greenback” which was used to pay the troops. Initially, this new money’s worth was equivalent to that of the gold notes that were also floating around the economy. By the end of the war though, these greenbacks had been depreciated (why? money printing) and had only a worth of one-third of the gold notes (gold backed currency), yet, the government was attempting to pay off debts and contract with them. So essentially, the government of the United States had decided to print a currency made completely of paper; one that had no inherent value and one that wasn’t backed by anything, and use it to pay off anyone and everyone who it was in debt to. Obviously, this didn’t go over very well. Those who were wise challenged this form of payment in court and won. This ushered in the era of the gold clause. This clause said that any obligations that the U.S. government had after the war were to be paid back with gold or the equivalent of what the gold was worth. This clause protected debt holders and those who were doing business with the government from being swindled by a shady currency that was losing any value it originally had.
The problem for Roosevelt was that the gold clause was still in effect when he allowed the dollar to be devalued. And because government contracts included this clause, the government was paying a fortune out to vendors and debt holders. It’s goal was to devalue the dollar to pay less in real terms, not pay the same amount as it had been previously. To deal with this issue, on June 5 of the same year, the president and congress passed a law that got rid of the gold clause. It said that it wasn’t responsible for adhering to it past, present, and future. Nada. Nothing. No more. The public as well as a few senators made some noise, but that noise made little difference. What was done, was done. The dollar was no longer linked to gold as it once had been.
To recap, over the span of just a few years during the Great Depression, congress and the president of the United States devalued the currency used by the United States, gave that currency full legal status, confiscated the lawfully owned private property (gold) of the average and ordinary citizen, made owning gold a crime, and tossed the gold clause out with the trash. So if you ever thought that the people of this nation had a say with the things that truly matter, you’ve been terribly mistaken. What will happen will happen, regardless of how much anyone kicks and screams. Interesting, isn’t it?
Devaluing the Dollar Against Gold in 1934
Can you imagine a situation where you agreed to work for $10 per hour and then went off to buy something after work that usually costs $10? When you get the store though, the person behind the counter tells you the item is no longer $10; that it’s actually $20 and will be from that point on. In fact, everything will be twice as much from that point on. Now, if you’re not a saver, this would be fine. You’ll hopefully (eventually) make twice as much an hour, so things will balance out. But what if someone owes you $100? When you loaned them the money, that $100 was worth whatever things were worth at the moment. Whether that be labor or goods. When they pay you back though, they’re only paying you back half of what that labor or goods are worth. They make out very well. If it was you who owned someone else money, you’d make out well.
In situations like these, who does well? Again, if you’re a debtholder, you win. Currency devaluation is always good for debtholders. They get to borrow when money is worth a lot and pay that money back when it’s not worth so much. It’s the lender who gets stuck being paid back devalued money. If you’re a saver and have got tons of money sitting in your bank account, you’d lose out big. The more a currency devalues, the less buying power your savings will have. In cases like these, the banks would win. Seems strange, doesn’t it? We all know that currency devaluation happens on a daily basis. It’s called inflation. We also know that borrowing somehow seems irresponsible and wrong. Beyond that, we know that saving seems responsible and right. Yet, it’s the borrowers who make out better than the savers. If you’re into fairness, give this quandary some thought.
Back in January of 1934, President Roosevelt signed an executive order that changed the price of gold from around $20 to $35. If you went to the bank on a Monday and placed $20 on the counter, you’d walk out with an ounce of gold in your pocket. If you walked in the same bank on Tuesday, you’d have to place $35 on the counter for the very same weight in gold. Can you imagine being one of the very few people who actually turned their gold over to the Federal Reserve when the United States government demanded you to? They would have paid you $20 per ounce and then right afterward, they would have said, “Sorry, but it’s now worth $35 an ounce. You lose.” As you can imagine, hardly anyone turned their gold over. Only 22% of the gold in circulation was given to the bank. For those who held onto theirs, they earned a hefty profit. What they had sitting in their drawer one day doubled in value the next. Not bad. Well, actually it didn’t double in value. It doubled in currency.
The worst thing about what Roosevelt did pertained to international trade. The price of imports practically doubled overnight, putting great strain on the U.S. population. Businesses who needed goods and supplies from other nations had to pay double. The problem was, they only had so much in their bank accounts. And the everyday Joe had to pay double too because the increased prices trickled down quickly. It was a mess. But if anyone owed money to anyone else abroad though, boy were they happy. They only needed to pay half.
It wasn’t all bad. Yes, some people were hurt, but the bigger banking picture was quite rosy. By devaluing the dollar and by increasing the price of gold, the U.S. government saved the fractional reserve system and all but stopped international runs on the dollar. If you look at the grand scheme of things, this was a preferable outcome to what could have happened.
Basically, what was happening at the time was that there wasn’t enough gold in storage to balance against how many dollars were in the system. There were far too many dollars due to a number of reasons – primarily money printing and lending. Since the balance was so off, the government had to rebalance things by changing how many dollars it took to buy a piece of gold. It used to be 20 dollars and after a certain point, it took 35 dollars. After the dollar was revalued, there was balance again.
What’s the moral of this story? It’s that banks and governments are fiscally irresponsible. They’ll never not create more money. That’s what they do. They create and lend and borrow and spend. It’s the name of the game. The problem is, there’s this pesky little thing called gold out there that seems to get in the way of everything. It’s built into the laws of economics and no matter how hard people and institutions try to avoid it, there’s always a reckoning. Too many people trust gold and not enough trust fiat currency. So when the time comes, currencies are revalued against gold. It’s always the same story. The more money there is floating around the economies of the world, the higher the price of gold. It may not happen gracefully or gradually, but it will happen. And from recent events, you can see that it happens dramatically. Currency revaluation will take place and those who own and keep gold will win. All you need to do is a little reading of history to see how and why.
What Saved Us From the Great Depression?
If you ask any grandparent out there what saved the United States from the Great Depression, they’ll tell you it was Franklin D. Roosevelt’s New Deal. If you aren’t aware, the New Deal was a series of programs, public work projects, financial reforms, and regulations enacted in the United States between 1933 and 1939. Your grandparents will tell you that because of all the government spending and good ol’ American hard work, we simply sprung out of the depression and enjoyed the greatest bull market the nation had ever seen. Some people will tell you the strong economy originated from World War Two spending, which was sort of like New Deal spending. After all, government spending is government spending. Whatever the cause, it usually stimulates all different types of things.
When you ask your grandparents where they heard these financial and economic theories, they’ll likely tell you it was through the newspapers. It wasn’t like the nation was saturated with televisions and the internet yet, so most people got their news from word of mouth and the papers. I can see the headlines now. “Roosevelt Wins New Deal!” “The Great Depression is Soon to be Left Behind!” “Let’s Move Forward Together – Let’s Dig!” All types of headlines poured off the printing presses back then. The question remains though – was it all fake news?
Let’s think about what really affects the greater economy. Let’s think about the happenings back during the Great Depression. Let’s think about global trade and the price of gold. Things that truly mattered.
When the United States Federal Reserve nearly halved the value of gold in U.S. dollars (raised the price by $15) with one fell swoop, prices for goods and services here at home didn’t follow suit immediately. They rose incrementally over time. What did occur immediately though were price changes for Americans purchasing foreign goods and price changes for American goods purchased by foreigners. Immediately, the cost of foreign goods for Americans climbed by 70% and the cost of American goods for foreigners dropped by 70%. As you imagine, the effects of these price changes had a dramatic effect on the amount of gold that was held by the U.S. Treasury. In the most basic sense, the outflow of gold from the U.S. was reduced to a trickle and the inflow swelled incredibly. Almost instantly, the United States was extremely gold rich. Why did this happen? Because Americans stopped buying imports (they were too expensive) and began exporting their goods en masse (American goods were really cheap to the rest of the world).
Another thing that occurred had to do with who the gold mining companies sold their gold to. Because the U.S. dollar was pegged to a new gold price, the government was obligated to purchase enough gold to sustain that price and to cover currency transfers for it. So basically, nearly every mining company around the world was, for a time, selling its mined gold to the Americans. This compounded the amount of gold we had stored in our vaults.
When the beginning of World War Two rolled around, something else that had a tremendous effect on the U.S. economy took place. Because of Germany’s occupation of Austria, many Europeans were downright spooked. They withdrew their investments from European businesses and placed them in American businesses. Also, because so many factories in Europe had been converted into production houses for ammunition, vehicles, and supplies needed for the war effort, there was a sharp decrease in the production of everyday goods consumed by those nations. The U.S. filled the gap and exported most of what was needed by the Europeans during those years.
Each of these forces played a large part in stimulating the economy of the United States, which pulled it out of the depression. Really, there was no stopping it. We were huge exporters of goods, those goods were very inexpensive for everyone else, and we had a huge demand for many items simply because those items weren’t being made abroad any longer. Combined, these factors led to the United States holding approximately two-thirds of the globe’s gold reserves. Incredible.
So did the New Deal save us from the depression? No, it didn’t. It’s just that what I said above isn’t common knowledge, unless, of course, you’re into investing and looking into global economics. I’m not sure how Roosevelt’s New Deal filled the coffers of the United States with a good majority of the gold available on earth. Simply put, we were rich and that richness wasn’t derived from government spending.
The Financial Results of World War Two
The United States of America was and still is a primary trading partner of many European nations. During the war, the U.S. was busy shipping energy, electricity, and ammunition to the Europeans so they could destroy the factories that had once produced these things. Essentially, nations abroad were paying the Americans to destroy themselves (the Europeans, that is). It was a weird, but necessary time. Our manufacturing base had grown by leaps and bounds and theirs was reduced to rubble.
What’s worse is that in order for the Europeans to save themselves from utter destruction (from each other), they were forced to liquidate much of their gold. By the time the war had ended, there was a tremendous trade imbalance between Europe and the United States.
Bretton Woods
The United States had control of the European financial system. It’s interesting how things just happen to work out, isn’t it? Listen to this. Because of the collapse of the global financial “order,” if you will, 44 nations met at the Bretton Woods resort in New Hampshire to hammer out the details of a new one. Really, they had no choice. Their economies were in shambles and they were broke. Many nations also didn’t have the wherewithal to rebuild. Their factories and roads were destroyed and they had very little gold to rebuild any of what they once had.
Surprisingly (not), the result of the agreement these nations came to was that each of the nations involved would link their currencies to the U.S. dollar. The central banks of these nations would also have the ability to trade their dollars for gold at $35 per ounce. So really, what happened was that, because of a war they began and fought, the Europeans and other countries were forced to alter their entire financial systems to revolve around the U.S. dollar. I find this incredible. If there was ever a reason for a small group of people to sit in a dark room, devising a way to get the world to destroy itself, this would be it. Nearly total control of the major financial markets and central banks around the globe.
Here are a few questions for you: what do you think saved the world from the Great Depression? What saved just the U.S.? What have you heard? Which version of history did you learn? A lot went on back then and I have a strange feeling that much of what was reported wasn’t very accurate. Or, perhaps I should say, it wasn’t very thorough. Personally, I don’t remember sitting in social studies class discussing the finer points of gold transfers between European and American banks.
Inflation & the Free Market for Gold
The 1960s were a tough time for governmental borrowing and gold prices. When the Vietnam War rolled around, there was no more asking by government officials for the public to make concessions. War bonds were a thing of the past as were economies that were based around a war. Granted, the Vietnam War was much smaller and more focused than World War One and Two, but still, there was much less involvement in it than had been previously, even on a scale by scale basis.
If there wasn’t much asked of the public, even by way of increased taxes, then how did the United States government pay for this venture? You got it – debt. They borrowed and borrowed and eventually all that borrowing earned itself a name that’s been entrenched in the national vocabulary since. It’s called deficit spending. And because there was less linkage than ever between the dollar and gold, borrowing was allowed to run rampant.
Because there was so much money printing going on in Washington, our allies abroad began asking for gold in return for dollars. Charles de Gaulle of France converted hundreds of millions of dollars into gold in just the span of a few months. Things got so bad by one point that a run on gold was created, causing an outflow of over 1,000 tons of gold from the U.S. by the end of 1967. It seems as though the more the United States devalued the dollar and Britain devalued the pound, the more gold both nations lost from their vaults. People with financial intelligence around the world saw what was going on and made the trade from fiat currency to hard currency, namely gold.
In 1943, the monetary base of the United States was on par with the amount of gold reserves we had. Within five years, the monetary base had jumped by over 50%, while the gold reserves reduced slightly. Up until 1958, the monetary base grew slowly and the gold reserves shrunk slowly. By the time the late 60s and early 70s rolled around, the monetary base had exploded in growth and the gold reserves had been reduced to such a point that the monetary base was multiple 100s of percent more than what we had stored as gold. What this means is that the United States had a dwindling reserve of real money and an ever growing supply of fiat money. Paper, if you will.
At this point, the London Gold Pool had stopped operation and the open market began setting the price of gold. The central banks attempted to keep the price of $35 per ounce tethered between gold and the dollar, but it was getting difficult to fight the market off. It seemed as though there was only one possible result of all this fiscal recklessness that could take place. Can you guess what it was? What could happen to the price of gold when it no longer remains pegged to a fixed price set by a bank? What could happen to the price of gold in dollars when the amount of dollars that was injected into the economic system was exponential when compared to what had been printed ever before? Please share your thoughts down below.
The World Moves Off the Gold Standard
Something odd occurred on August 15, 1971. That was the day President Richard Nixon moved the world off the gold standard. The dollar was no longer convertible for gold at a set price. The price of $35 per ounce. Because the price of gold had risen so much through the years and had gained a market value unto itself, I can only assume that the government wasn’t very interested in letting it go for such a low price. From the point Nixon detached it from the dollar, both the dollar and gold were completely free floating. And since all the world’s currencies were backed by the dollar, which used to be backed by gold, they were then only backed by the dollar, which was totally fiat. At that point, everything was fiat and gold was free to price itself at whatever the market deemed fit.
Two things happened when Nixon took the world off the gold standard; one, the Bretton Woods system failed and two, the United States essentially claimed bankruptcy. But since the U.S. Dollar was still used as the world’s reserve currency, the rest of the world had nowhere to go, so they stayed put. There wasn’t really any great alternative.
It was at that moment that the United States gained a tremendous advantage. Basically, the Federal Reserve could now print any amount of money and lend it to the U.S. government, which meant that congress and the president was able to maintain a standard of living for the population that far exceeded anything the people of the nation deserved. From that point on, budget and trade deficits was the norm. Even today, the practice of printing our way to prosperity continues. Just this very week, congress passed a stimulus package that exceeded $1.9 trillion. Each and every penny of that stimulus was borrowed and will eventually need to be paid back. Starting in 1971, the United States government began shedding any amount of fiscal conservation it ever had and that shedding has gotten worse every year thereafter. These days, there’s not a shred left. While some in congress may claim that there’s not enough money to go around, what they really mean is that there’s not enough money to go around to fund their projects. Both parties love borrowing and spending. It’s become a way of life.
Are you ready for an interesting phenomenon? We all know that the United States borrows money from whomever will lend it to them, whether it be the Federal Reserve, the citizens of the U.S. and those around the world, or other governments from various countries. When someone lends the U.S. government, say, $100, since the government borrows so much money through debt, it’s essentially adding that debt (new money) to the monetary supply of the world, causing inflation. The Federal Reserve says that it’s got a target inflation of 2% per year. What does that mean? It means that after you lend the U.S. government $100 one year, it inflates the currency to a point that you’re only getting back $98 in value. Sure, you may actually get back more dollars than you invested because of interest, but in higher inflation periods, you’ll receive less value. This is what people in the know call the “inflation tax.” It’s a hidden tax that very few people discuss, but it’s a real force that eats away at your savings year in and year out. If you don’t pay attention to it, it’ll chew right through all the cash you’ve got in your very low yielding checking and savings accounts.
Interesting things happened when the dollar’s link to gold was severed. Interesting things indeed. None of them great. I’ll discuss all of these things in later posts.
The Golden Bull
What have been the greatest drivers of gold price increases throughout history? I’ll tell you. An increase in the money supply of a nation and the public’s awareness of that increase. The public becomes nervous that the paper money they hold will purchase less of what they’ll need, so it converts its paper money into metal money. It’s that simple and this type of thing has happened over and over again throughout history.
The other driver of the increase in the price of gold is the printing of the money itself, although this type of increase isn’t as dramatic as the previous one has the potential to be. As the paper money supply grows in any given economy, so does the price of gold in that economy. It’s one of those laws of economics that we haven’t been able to get rid of yet. It’s just the way it is.
If you’re old enough to remember the 1970s, you’re old enough to remember some intense inflation. I remember my mother telling me about couples who had 16% or more interest rates in their mortgages. Today, we pretend there’s a huge difference between 4% and 4 1/4%. Try paying 16% if you want to know what throwing money out the window feels like. It was nuts.
Because of all the money printing that occurred during the 1960s in the United States as well as all the printing that occurred after the second world war, inflation was on the rise drastically throughout the 1970s and part of the 1980s. And if you remember that inflation from your own personal experience, you likely recall the oil embargo that occurred in 1973. Some people say that this embargo was one of the primary drivers of the monetary inflation that was occurring at the time. These people would be incorrect. What was actually happening was that the holding back of oil was actually driving the price of that raw crude back up to the point it was during the Bretton Woods agreement. You see, the oil producing nations in the Middle East knew all about currency devaluation and when they realized that they were getting paid pennies on the dollar for what their oil was actually worth, they began holding it back to create a squeeze in supply. Because supply became so tight, the price rose drastically, which put it back in line with what it should be. It’s sort of like having to work for $5 per hour and not getting a wage increase while the price of bread increases from $1 to $2 to $4 to $8. Obviously, you’d ask for a raise because you wouldn’t be able to live soon enough. If you had enough clout, like OPEC did, you’d get that raise. Sometimes you have to play hardball.
Do you remember when I said that the U.S. government made it illegal for any citizen to own gold? Well, in 1974 they made it legal to own again. And since its price was no longer pegged to the U.S. dollar, it was allowed to float based in market demand. Can you guess what happened to the price of gold once it became legal to own again? Yes, that’s right. Because of all the additional dollars that had found their way into the global economy, the price rose from $35 to $50 to $100 to $200 to $300 and beyond. The market was resetting the price, just as it did for many other commodities, such as oil, wheat, pork bellies, and so on.
Before I end this post, I’d like to point out one small detail in regards to “money printing.” When that phrase is used, many folks think of actual physical dollars being printed on a printing press. While that does happen, most money printing occurs in the form of debt issuance. In today’s day and age, that debt issuance is to the many governments around the world. You’re surely aware of how much the United States government borrows to pay for all sorts of things. Another type of debt that needs to be taken into account though is consumer debt. Each time someone uses a credit card to pay for an item, the currency supply is increased. Yes, that money is never actually seen, but once it hits a vendor’s bank account, it becomes part of the system. So while government borrowing does cause inflation, so does consumer borrowing. Think credit cards, car loans, mortgages, personal loans, student loans, and anything else people borrow money from banks for. We’re all in this together and the more we borrow, the more expensive things become.
Booms & Crashes
Have you ever noticed how things in the economy seem to move with a sort of mass agreement by the populace? What I mean is that when bubbles in the market occur, everyone talks about them. Everyone wants to get in while the stock prices are moving up, usually when they reach the peak. I’ve actually experienced this myself. When there’s a big run-up in anything, there’s a voice inside of me that tells me to get in on the action. The problem is, by the time I notice what’s going on, it’s usually too late. The run-up has already occurred and I’m a day late and dollar short. Far too many people have lost far too much money trying to get in on a boom. They spent everything they had and took out loads of debt to purchase something that was way overpriced. I guess it’s just the way it is. The real problem here is that booms sometimes take decades to come to fruition and mere days to bust. What’s person to do when they think the stock market or the housing market is simply going up, up, up like it normally would? The average person thinks whatever is going on is normal. They have no idea they’re living in a fabricated economy that’s ready to deflate at any moment.
Do you remember the stock market crash of 1987? I only do a little bit. I was pretty young back then. I remember hearing about it, but I honestly wasn’t too concerned about global finance in my early days. They say it was the largest one-day crash in history. The weird thing is that no one has ever come up with a definitive reason for the crash. Some say it was caused by day traders, others say it was a lack of liquidity in the market, and others say a simple overvaluation was to blame. When traders began to sell, there was a cascading effect in the market and the resulting plunge was huge. Most intelligent folks believe it was a psychological event that wouldn’t have occurred if the general public along with their trading counterparts weren’t spooked by rumors swirling around the econosphere. I just made that word up, but you get the idea. When a few people get spooked about their money and rumors begin to make it out into the mainstream, the entire herd goes nuts. This isn’t the type of thing the stock market wants or needs. It causes massive sales and even more massive repercussions.
Personally, I think market manipulation by the Fed was to blame. Knowing what I know now about how markets get hot and then cool off, I know that the Fed is behind a lot of the terrible things that happen. I also know that the Fed has helped tremendously throughout history, so I don’t want to act as if it’s some sort of awful institution. I really don’t know enough about it to make that call. What I do know is that the global economy is very large and it has many, many players. Some of them are good and some not so good. Powerful interests can bankrupt entire counties in one fell swoop. If there was a glaring deficiency in how things are traded, it would be that some individuals and corporations hold far too much power and are accountable to no one. This probably won’t change any time soon.
Back in the late 1970s and into the early and mid 1980s, the Fed had to adjust interest rates upward to first get inflation under control and then adjust them again downward to stimulate the economy because of the suffering those earlier high interest rates caused. While this was happening, injections of currency were flooding the economy, which caused massive overvaluations of everything from stocks to homes to businesses. As prices were rising, herd mentality set in and people became very comfortable with those price increases. They invested in the stock market and bought and sold homes. The economy was hot. Actually, it was too hot because on October 14, 1987, the market began dropping and when it was finished dropping a few short days later, the Dow has fallen over 22%. That’s pretty big. I guess something had to give.
Because so much liquidity had been removed from the market so quickly, the Fed had to push more of it into the same market. This additional currency caused real estate bubbles to spring up all over the country. What’s interesting to me is that liquidity didn’t actually “evaporate” from the market and find its way into thin air. As far as I know, when the stock market goes down, it’s because people sell their positions in businesses. The money the sellers get from their sales is parked in something akin to savings accounts. So really, there’s the same amount of money swirling around the economy, it’s just that a lot of it isn’t active. So when the market goes down and the Fed pumps it back up, isn’t the Fed really just exacerbating the problem? Won’t the money that was pulled from the market eventually return, only to pump it up even more? Unless, of course, the Fed’s pumping is only temporary with the intent on steadying things out until they see the market return to normalcy. When that happens, the Fed can sell whatever it is they bought and everything will be good again. I really don’t know, but I do find it fascinating.
Inflation During the 1970s-80s
I can remember my mother telling me about monetary inflation during the 1970s and 1980s. My parents purchased their first home in 1964 for $16,000. By 1975, it was appraised for more than $50,000 and then later on again in the mid to late 80s for over $150,000. They eventually sold it in 1998 for just over $200,000. I always wondered what caused prices to climb so high so quickly. It seemed as though those who had homes and who were willing to sell them made out like crazy, while those who were looking to buy had to pay a lot more every year they waited. Apparently, the price increases in the late 80s were cause by the Fed injection of currency into the economy due to a stock market collapse of 1987. Every time the Federal Reserve creates more money, prices climb. Sometimes, they climb very quickly, as they did in the 70s and 80s.
Whenever there’s a large stimulus from the Fed, there’s usually a large boom in some part of the economy afterward. In 1988 and 1989, because of the money that was printed, housing prices went nuts. And because there was a new bubble forming in real estate, the Fed was forced to react by increasing interest rates. They do this in an attempt to cool the economy off. So those who were looking for a new home to buy, not only had to pay higher prices for the home itself, but higher prices for mortgage interest. Everything was higher all around.
Unfortunately, because of the dramatic increase in interest rates from the Fed, the housing bubble burst, which caused a nationwide recession. I remember this well. All I we heard about back in the early 90s was that there was a recession and what we needed to do about it. Politicians were talking about their “plans” to deal with unemployment, wages, housing, and everything else. I remember walking around near my grandmother’s house during that time thinking to myself. I said, “If every citizen of the United States just spent $1 on something, we could pull ourselves out of this terrible recession!” How foolish I was in those days. To think that we the people had anything to do with our very own economy. All the ups and downs we experienced our entire lives were caused my monetary policy. And monetary policy is controlled by the Federal Reserve.
Because of the recession during the early 1990s, home prices fell. The Fed deemed the fall in prices too drastic, so they began cutting interest rates in an attempt at stimulating the economy out of the downturn. They chopped 8% rates down to 3% and even further. Nothing seemed to have an effect and home prices continued to fall. Builders stopped building and banks began foreclosing on those builders for the half-built homes. They also foreclosed on those who bought homes at the peak and who could no longer afford them. By the time the economy evened out, home prices had dropped to about one third of their peak prices. The frenzy was certainly over and there were a lot of pieces to pick up.
If you’ve never heard of the term “underwater,” this is what it means. It’s basically when someone mortgages a house that was once worth $100,000, but who paid $1,000,000 for it at a high interest rate. When a downturn in the economy hits, the price of the home drops to a fraction of what they bought it for and they owe the bank more than the house is worth. The problem with this scenario is that because the buyer paid way too much for the house at such a high interest rate, when they go to the bank and try to refinance their mortgage, the bank won’t touch them with a ten foot pole. What bank would refinance a $1,000,000 mortgage for a house that’s only worth $300,000? That’s a losing proposition for any bank and during these types of situations, homeowners are either forced into foreclosure or have to eat those high payments until housing prices rise again. This is what happened to millions of people back in the 90s. Luckily for them, there was another bubble just a short decade later. If they stuck with their homes and didn’t foreclose, they were able to sell at a later date.
Between the years of 1995 and 2005, more currency was created in the United States than the 90 years preceding this time – combined. There was an enormous currency creation during these years, and if you lived through them, you remember the result. A housing bubble that put all other bubbles to shame as well as the introduction to a word we all became very familiar with – derivatives. Everything in the U.S. went up, from stocks and bonds to house prices and derivatives. Not to mention, consumption and debt as well. That went up big time.
Dot-Bomb
Back in the late 1990s, a very strange thing was happening. I remember it well. I had just graduated graduate school and the company I was working for was throwing money at things. They were purchasing ridiculous supplies and services and were hiring ridiculous employees – all because they had too much money. If memory serves, they hired a guy to make logos and hired another guy to fill the role of Chief Happiness Officer or something like that. Companies at the time had no idea what to do with all the funny-money that had sitting around, so they began throwing it at other companies, people, and products. The tech companies were the worst. I have a friend who graduated with an undergrad degree in pretty much nothing and went to work for a tech company right out of college. His starting salary was $70,000. The kid was 21 years old! I remember telling him to save his money. Don’t spend it because it’s not going to hang around for long. I mean, how could it? The situation the United States was in was untenable. It was obviously in a bubble.
So what was going on at the time that provided so much money to so many companies and individuals? Well, for starters, the Fed was concerned about the fallout of Y2K. If you haven’t lived through that bunch of nothing, count yourself lucky. For years, we were warned about the impending doom the dates inside of computers throwing errors would cause. In 1998, I remember listening to the radio where a woman called in to tell the world that she had purchased so many cans of food that she was making couches out of the boxes. On New Year’s Eve, 1999, I went to bed thinking that I would awaken to the apocalypse. When I did wake up, absolutely nothing had changed. I can’t remember hearing even one report about a computer that malfunctioned. The entire thing was a fabricated fear porn story that was used to inject massive amounts of liquidity into the economy. Why? I have no idea, but it gave birth to the dot-com bubble that enabled my friend to land a $70,000 job right out of college. I wonder if he puts that one on his resume today. I’ll have to ask him.
What was the dot-com bubble? It was a time when technology companies came into their own. Because of all the market liquidity, thousands of tech companies were being born every day. Many of them went public and offered stock. A lot of these companies were reputable and offered good products, but some of them were nothing more than a guy sitting in his basement making websites. It seemed like each and every company that went public, instantly made the owner’s rich. It was a crazy time. Like all bubbles though, this one burst. The bursting effectively put the great majority of tech companies out of business. Even some large companies failed in the wake of the market crash. Companies such as Enron, WorldCom, and Global Crossing, if you remember them.
The Nasdaq is the market that trades many tech companies. For 14 years before the mid 90s, the Nasdaq was valued below $1,000. In 1995, it broke the $1,000 mark and by March of 2000, it hit $4,900. If you owned the Nasdaq index during that time, you had about six months to sell at over $3,500 and just a short time to sell at the peak of over $4,500. You could have made a killing if you timed the market right. If you bought when it was high though, like so many people did, you could have been wiped out. The index fell to about $1,200 a year later. But all was not lost. If you merely held on for a few more years, you could have made more money than even the biggest money makers back then. Take a look at this chart:
Talk about bubbles. We’re in one right now. This one makes the dot-com bubble look like a pimple on a baboon’s bottom. Granted, there’s a heck of a lot more liquidity in the global economy today than there was back in 2000.
Old time investors do a lot of talking today about picking the right companies. Companies of growth or value or whatever. In my humble opinion, stock picking is like a lost relic. It’s over. Investing is all about markets today and the overall S&P 500 is one of the biggest players. Even well run, ultra valuable companies have their stock prices slashed unnecessarily because of overall market drops. Because of the popularity of mutual funds and ETFs these days, individual companies get swept up in overall market purchases and sell-offs. So don’t bother attempting to value a company, unless you’re working for a ratings agency or a finance department of a large corporation.
I want to make one final note about this dot-com bubble topic. Whenever a bubble pops and a market plummets, wealth wasn’t destroyed in any which way. In order for a bubble to pop, investors had to sell. It’s those sellers who strode away with all the cash. Eventually, they’ll put it back in and the market will begin to grow again. So any wise investor would tell you to ignore market prices and go on with your day. Just keep your investments put and don’t even think about it.
What’s the Value?
Boy, Mike Maloney had no idea what was to come. In this first section of chapter seven, he talks about how the Dow Jones’ value was creeping past $13,000 and heading towards $14,000. He makes light of the situation and talks about the Dow shooting past $20,000 or dipping under $10,000 in the future. I’m guessing this was around 2008, just before the big real estate and market crash. If anyone wondered what the Fed was going to do about that crash, the verdict is in. They were going to print money. Do you know how I know they were going to print money? Because they did. As I write this, it’s 2021, we just had one of the worst real recessions in history because of the COVID-19 pandemic and yet, the Dow is currently priced at $33,991.73. When they print, they sure do print. I feel bad for those who decided to “play it safe” and keep their cash in the bank and not invest in the stock market. From then until now, the market has screamed while cash has lost a tremendous amount of value. Don’t believe me? Go buy a Ford pickup truck that would have cost $25,000 a few decades ago. It will cost you $65,000 today.
I remember listening to the news back near 2008. Ben Bernanke of the Federal Reserve was being interviewed and was asked how much liquidity would need to be injected into the economy to overcome the damage from the housing bubble and other bubbles from the decade before his interview. Would it be a few billion? A trillion? Do you know what he said? His reply was that the Federal Reserve would need to inject 100 trillion dollars into the economy. Right there, I knew I needed to get my money into the market because what they refer to as “quantitative easing” only does one thing. It pumps up the stock market. If you look at the S&P 500 or the Dow Jones Industrial Average over the past 13 years, you’ll see exactly what I’m talking about.
Check this out. Look at the market beginning in 2009. This is what funny money does to an economy. This increase isn’t from company earnings or efficiencies. This is all from Fed intervention via government debt, security purchases, and whatever else they do.
I wonder how long they’ll pump and what the end result will be. I also wonder if they are merely reacting to existing conditions or if this was all pre-planned. I mean, you have to think and hope it was pre-planned. No one could actually be this bad at banking.
Mike says that no matter how many dollars it currently takes to buy a house or by the Dow Jones, both of those things are and have been crashing for years. I’m assuming he’s referring to their value versus the value of gold.
The Dow is Crashing!
Here’s something to think about and is certainly appropriate for today. Back in October of 2006, the Dow Jones Industrial Average broke its old record of $11,750. The media reveled in glee. Things were good. Everyone seemed to be making money in the stock market, but behind the mirage, something insidious was going on. While most people thought they were getting rich, a few wise souls knew they were losing more and more money every single day they stayed invested in the market. They knew that the Dow had actually peaked back in 1999-2001. Because they were smart investors, they left the stock market and put their money elsewhere. So, what was it that these savvy investors were aware of that everyone else wasn’t? I’ll tell you.
Let me try to explain this in the most simple terms I can. Let’s pretend that you lived in Zimbabwe in 2007 and were invested in the stock market over there. You had all your money in Zimbabwe companies. One day, you began to notice that the “value” all of your investments were rising, no matter what you were invested in. Everything was going up. While you were thrilled with this revelation, you were also suspicious of what was going on. “How can everything be going up?” you asked yourself. “If one area is rising, shouldn’t another be falling?” you questioned. In a typical and healthy market, when one sector is rising, another is falling because of the exchange of currency between the two. It’s sort of like a see-saw. In a healthy market, stocks, bonds, real estate, commodities, and everything else would be rising and falling opposite one another. When stocks are hot, investors take their money out of bonds to invest in the stocks and vice-versa. When everything is rising at the same time, it can only mean one thing – inflation. Or, otherwise known as money printing. The more money that’s thrown into an economy, the higher the prices of investments will rise. The problem is, the higher the prices of investments go, the lower the value of the currency will fall. If, in 2006, it took one hundred Zimbabwean dollars to buy one share of a stock and then in 2007, it took one hundred thousand of those same dollars, something fishy was going on. Most likely, it meant that there was far too much money being injected into the Zimbabwean economy, driving down the worth of its currency. Now there was the real see-saw – the balance between investments and currency. When one goes up, the other goes down.
Does this story sound familiar? Have you ever experienced all asset classes rising in tandem right here in the USA? Of course you have, it’s happening right now. Because of various reasons, the Federal Reserve has printed massive amounts of money and has pushed it right into people’s pockets, whether they wanted it or not. And all of this money printing has created inflation. We’re seeing it everywhere.
Right now, the DJIA (Dow Jones Industrial Average) is sitting right below $35,000. As investors, how can we determine if this is a good or bad thing? How can we find out if our investments are actually becoming more valuable? Well, one way to do that would be to measure the dollar verses other asset classes. Measure its purchasing power against real “things.” If the same people are growing soybeans and the same people are eating the same amount of them, the value of those soybeans doesn’t change. If it takes $1.99 to purchase a pound of soybeans one day and $3.99 the next, something changed. If everything else is stable and there are no weird disruptions, I’d say the value of the dollar dropped. You can measure the value of the dollar against a lot of things. All sorts of commodities, real estate, stocks, oil, gold – lots of stuff. The value, or worth, of these hard assets doesn’t often change. The value of the dollar does though. To measure the Dow to see if it’s been gaining value, all you need to do is divide its price into the price of other asset classes. Back in the first decade of this century, a few people did that and realized that the Dow has been crashing for years. While most investors thought they were making money hand over foot, they were actually losing it due to inflation. They had no idea. From 2002 to 2008, the dollar has lost over 35% when compared to other currencies around the world.
When comparing the price of the Dow to the price of gold, think about this: Back in 1999, it took 45 ounces of gold to purchase one share of the Dow. In 2008, it took fewer than 15 ounces. Did the value of gold rise? No, that stays fairly stable when measured against other hard asset classes. It was the price of gold when compared to the value of the dollar that changed, meaning, the value of the dollar dropped a lot. During those years, the value of the Dow Jones had dropped by 67%, all the while, rising in cost in dollars. Strange? Strange. That’s inflation for you. Again, it’s insidious. It sneaks around and it’s difficult to feel. Except at the food store and when paying bills. Then it’s very easy to feel.
During the first decade of the 2000s, the Dow has dropped against many different commodities, from 40% all the way up to 85%. When measured against gold, commodities, agriculture products, crude oil, industrial metals, silver, the story is the same. The Dow plummeted and the “stuff” rose. Really though, the stuff stayed the same and the Dow dropped.
To be continued…
Leave a Reply